Montpelier Re: Trading a Heavy Discount to Fair Value

 |  About: Montpelier Re Holdings Ltd. (MRH)
by: Ryan Freund

Montpelier Re Holdings, Ltd. (NYSE: MRH) is a holding company whose principle operating subsidiary MRH Reinsurance Ltd., is a provider of global property and casualty reinsurance and insurance products.

MRH seeks to identify attractive reinsurance and insurance opportunities by capitalizing on their management’s underwriting experience, using catastrophe modeling software and their proprietary risk pricing and capital allocation models.

Within their reinsurance and insurance business, MRH primarily writes the following three lines of business: property specialty, property catastrophe and other specialty.

In 2005, MRH Re was hit hard by Hurricane Katrina and subsequently lost more than 50% of its stock price. The stock price tumbled to the low-$40s to its current share price of $18. See the chart below, courtesy of CNN Money.

While this drop was justified at the time, as MRH suffered significant losses post-Katrina from paying out re-insurance claims, it is no longer reasonable for the stock price of MRH to be so low. The company shored up its risk management and is now much better suited to avoid such dramatic losses. 2007 was a good year for most insurers and re-insurers alike, with very few natural disasters, and thus smaller claims to be paid out. Yet the price is still near its 5-year low.

Financial Strength

A classic value play, MRH has a book value of nearly $16 per share while trading at only $17.80. Add the dividend and the earnings per share, and we get an intrinsic value of nearly $20. This means that the current price is nearly 15% lower than the trailing twelve month value. This does not even account for future growth. MRH saw a 20%+ jump in net income from Q1 2007 as compared to Q1 2006. That’s certainly worth accounting for.

In terms of valuation metrics, MRH has an extremely low 6.44 forward price-to-earnings ratio and a price-to-earnings growth ratio of only 0.61.

As if these numbers weren’t enough, MRH has nearly $3 billion in cash and short-term investments, and less than $430 million in debt. It’s important to note that the market capitalization of MRH is only $1.82 billion as of November 15th, 2007. Subtract the cash they hold and add the debt, and you get an enterprise value of nearly -$600 million. This means that investors get shares of MRH for $17.80 per share, when MRH has nearly $24 per share in cash! The shares purchased are being obtained at a 26% discount to just the cash held per share. This doesn’t even include the earnings per share or the dividend. Add those and it becomes a 41% discount to total value.

Insider Buying

MRH is trading a heavy discount to fair value. This is primarily because the insurance industry as a whole is very cyclical and is in a down period right now. The insurance landscape has changed drastically since Katrina, and investors are more wary than normal about the possibility of another Katrina. However, MRH has done a great job spreading risk out and reducing policies in highly risky areas. This has led to a decline in revenue, to an extent, but its well worth the assurance that a major catastrophe won’t affect MRH as much.

What better way to test the theory that this stock is undervalued than to look at the actions of those who know the company best, the insiders?

In the past year, insiders have purchased nearly $2 million worth of stock at prices near today’s price of $17.80. They believe MRH is undervalued, and we agree.

Dividend record and rate

MRH has paid out a dividend since 2003 and lowered it in the wake of Katrina. The dividend currently sits at 1.7%. After a few more quarters of revenue and earnings gains, it is likely that MRH will improve its dividend and may even buy back shares at this depressed price. When they do, Wall Street will start to pay attention again and realize the value that FI and MRH insiders already have.

52-week target

The stock price of MRH, in 52-weeks, will be higher than it is today. While it is difficult to predict how much higher, by analyzing their intrinsic value and future growth, MRH shares could easily approach $28 per share. This represents over a 55% gain from today’s levels, which includes the dividend.