Universal Insurance Holdings: A Worthy Speculative Play

Jun.25.08 | About: Universal Insurance (UVE)

In my opinion, one of the best investors of our time is Peter Drucker. If you have never heard of this man, you are missing out.

Drucker has held his own legend in the sphere of executive management [almost every MBA student and CEO has heard of this man]. Accordingly, he is the father of management, writing the commandments as to how management ought to be implemented throughout a corporation. If one were to go back to the first few novels on management published by Drucker, one would find that the majority of today’s “hot executive business books” will, without a doubt, spew the main points Peter had been teaching his entire life.

Sadly, the man passed away in 2005—a reminder that in the end—we are all mortal. And it’s because of mortality that we must also be wary of the cyclical nature inherent in markets. [Note: It is also interesting to see the boom/bust phenomenon one sees in nature—refer to the topics of “environmental & ecological engineering.”] Moreover, Jack Welch was the only actual student of Peter Drucker who turned to him when he became CEO of GE to ask for advice and wisdom on how to run the company. In turn, Welch added billions of market capitalization for GE.

To take a word of wisdom from Drucker:

Profit serves three purposes. One is it measures the net effectiveness and soundness of a business’s efforts. Another is the “risk premium” that covers the costs of staying in business—replacement, obsolescence, market risk and uncertainty. Seen from this point of view, there is no such thing as “profit”; there are only “costs of being in business” and “costs of staying in business.” And the task of business is to provide adequately for these “costs of staying in business” by earning an adequate profit. Finally, profit ensures the supply of future capital for innovation and expansion, either directly, by providing the means of self-financing out of retained earnings, or indirectly, through providing sufficient inducement fro new outside capital in the form in which it is best suited to the enterprises objectives.
– 'Practice of Management', Drucker

Key Action Point: Profit is the ultimate test of business performance. Decide to pull the plug on an unprofitable business if it is not covering the cost required to stay in business or providing enough capital for future growth.

Q: What does this have to do with Universal Insurance Holdings Inc. (NYSEMKT:UVE)?

A: Everything!

Market Theory 101:

As investors, we need to find companies that separate themselves from the crowd—and the best way to do this is by looking at their performance in the realm of profit and cost control—the spread between keeping the lights on and getting a check. Moreover, the market, over time, does reward companies who manage to execute on their business. In essence, there is a lot of money that is required to be put to work by fund managers all over the world and very few places for these ideas to obtain the required rate of return that would satisfy either high net wealth individuals or sovereign wealth funds.

UVE remains relatively undiscovered and has been doing better than its competition in a time of stress for the financial industry—thus permitting me to bestow upon them my own AAA status.

About UVE: The Company is a vertically integrated insurance holding company. Through its subsidiaries, the Company is currently engaged in insurance underwriting, distribution and claims. UPCIC, which generates revenue from the collection and investment of premiums, is one of the top five writers of homeowners' insurance policies in the state of Florida and has aligned itself with well-respected service providers in the industry.

Oddly enough, with much preoccupation with Oil, Capital Hill, Inflation and Bernanke, investors have left open, in such times of chaos and fear, investments that otherwise would not go unnoticed. UVE is actually a text book situation Buffett-like value players would be happy to obtain at these levels.

1. In Q1 2008, UVE diluted earnings grew by 16.7% vs. Q1 2007. At the same time, stockholders' equity grew by 19.1% to $84.4 million from $72.6 million between the months of Dec 2007 to March 2008. Continued growth in UVE was exemplified in their policy counts—as the company was servicing approximately 399,000 clients, up from 374,000.

a. For year end 2007—a significant earnings environment as this was the avalanche month for financial companies—total premiums earned and other revenues increased 43.8% in Q4 and 189.4% in FY 2007.

b. For the year-end 2007, earnings per diluted shares grew 20% in Q4 and 222% in FY 2007.

c. Stockholder equity [last time I checked, this was book value] increased to $72.6 million FY 2007, up from $22 million FY 2006. This represents book value return of 230% between 2006-2007.

2. Year-end EPS was $1.31 per diluted share, providing an earnings yield of 39%. Compared to most investments out there—this is by far one of the most attractive ones. [For die hard p/e investors, this is a little less than 3x earnings you are paying based on 2007 year end data.]

a. In the 12 months of FY2007, gross premiums written increased 34.2 percent to $498.7 million from $371.8 million for the same period in 2006, primarily attributable to an increase in new business as well as premium rate increases. The increase in new business is partly attributable to the 2004 and 2005 Florida windstorm catastrophes, which have provided an opportunity in the otherwise competitive marketplace, as certain companies are not accepting new business, as well as marketing initiatives the Company has undertaken. Also in FY2007, net premiums earned increased 185.4 percent to $154.4 million from $54.1 million in the 2006 period, primarily due to an increase in new business, premium rate increases and changes in the reinsurance program.

Playing with Shareholder Equity: Some Basic approaches to open investors' eyes to UVE.

UVE shareholder equity [book value] grew from $9,916,000 in 2005 to $72,575,000 in 2007. Lets assume that $9.9 million is the present value of a loan, and that in 2 years, the future value of the loan is now worth $72.5 million. The investment yield, or IRR compounded annually, would be 170.54%

  • IRR compounded quarterly would be 113%
  • IRR compounded half-monthly would be 101.62%
  • IRR compounded monthly would be 103.77%

The owners of UVE have done a great job, and while insiders' stake of shares outstanding is 58%, it will probably be diluted thereafter as the company begins to initiate its PR. Even still, this is a huge stake by management to do well and grow the company with an aggressive stance for profits without sacrificing unwanted growth [not all growth is good-growth for the sake of growth is not good, as it destroys enterprise value].

The company also has about $214,000 in cash, up from a mere $48,000 in 2005 [2 years ago]. What this tells me is the ability of a firm to generate cash. Now most investors may quip on how this is not being plowed back into growth and acquisitions. Actually it is, but with care—which is the best type of decision making I enjoy seeing when a firm is starting to get big—it doesn’t get ahead of itself and remains within the guidelines of operations that brought it to where it is today.

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Bottom Line: UVE is a great situational stock to have in your portfolio. While it may be small with a market cap of about $158 million, the firm has enough cash reserves that it would have to take something catastrophic to put it out of business. Strong relative strength and market appreciation in such a heated financial environment proves that UVE is favored by the market. [Looking at relative strength is the best way to look at whether your stock will stand up and outperform in the given quarter or not.]

Risk: I would have a risk position to be stopped out at $1.57. Accumulate slowly over weeks to months and pyramid into your trades. The time frame for this position trade is 6 to 18 months. While this may be 5% of your entire portfolio, if you are an aggressive investor, with strong gains over time, the returns and portion of your trading account will increase. Size and heft will come as returns come. In trading, there is no need to start off with your max desired position. It is best to build into them as your positions return a profit within a few weeks of holding. This diminishes risk and increases probability of success.

Happy Speculating.

Disclosure: Long