I wrote about Old Republic International (ORI) a few times, with the last valuation pegging it around $9.30 per share. As the company just reported Q3 2012 results it is time to update any significant change from that valuation. In the context of this article, it is important to keep in mind, the last valuation I considered to be relatively conservative, at least based on the concept that CCI will not result in a massive loss (not massive enough to require more capital or impact the dividend). Based on the company's core operating focus I believe the main consideration should be the General Insurance and Title Insurance segments, with an eye on the risk of the RFIG business. The article is written with that in mind.
The company recently announced earnings for the 3rd quarter of 2012 (and first 9 months of 2012), which had a lot of similarities to Q2 2012. The company separates its run-off businesses from its on-going business (RFIG and CCI being the run-off businesses) when presenting results, which can be a bit confusing to some (as they don't always understand that RFIG includes two distinct businesses). As it relates to the on-going business the company saw good top-line growth, with revenue increasing 19.4% year over year for the quarter. Premium growth was strong with the General Insurance segment growing over 15% and the Title segment growing north of 35%. The pricing environment seems strong which is part of the story behind the premium growth and is something echoed in the results of other large insurance companies like Traveler's (TRV) and Chubb (CB) (you need to dig into the results to find the comparable parts as both of those insurers compete across a broader product line).
Similar to Q2 the company has seen the General Insurance segment have relatively large increases on the costs/claims side. Even with the 15% growth in net premiums the segment is showing a decline in operating income by almost 22%, which is driven mostly by the 22% increase in claims costs. Per the conference call and earnings release this was largely driven by the workers compensation line, which is driven primarily by a poor economic environment and more specifically, a poor employment environment. Basically they are seeing inflationary costs on the healthcare side and an increase in costs as they adjust their reserves (based on each quarter's updated view). The composite ratio is right at 99.5% for the segment, which is worse than a year ago and not particularly strong economically speaking.
The Title segment continues to turn in very strong results, with operating income 125%, even if it is from a small base. The company continues to see benefits of the overall market as refinancing activity is strong as a result of the low interest rates. Additionally, based on a lot of the fall-out some years ago the company says that a lot of this performance comes from gaining market share. The composite ratio improved a couple of percentage points to 96.2% and continues to be a bright spot for the company.
For all segments the interest rate environment continues to be a drag on earnings. As the company invests a significant portion of their asset base into fixed income securities, the low interest rates provides very little in the way of interest income. This is likely to continue for the foreseeable future as the company wants to maintain a conservative investment policy and rates aren't likely to increase any time soon.
Looking at the run-off businesses, which are captured in the "RFIG" subsidiary, I won't spend a lot of time to go over the results. Effectively, everything I said in the last quarter article should cover the legal structure and history behind these (to the extent I thought it was relevant). Additionally, on the Mortgage Insurance side of the business, the results remained basically the same. That is, they continue to produce significant losses, would require new capital to re-enter the business, and continue to have the claim by the company they are "walled off" and won't require new capital.
The main difference in the RFIG results was on the CCI side. CCI had a significantly better performance when viewing vs. last quarter, with an operating loss of $6.9M. That compares to last quarter's loss of $50M, although this quarter's loss is much more in line with most other quarter comparisons (so perhaps last quarter was the anomaly).
Risk and Uncertainties
The primary risks for this company remain basically the same and I see no real new information from these results to warrant any change of opinion around the main risk. The company still has the risk that the Mortgage Insurance segment will be taken over and if that happens it could force a default on their debt. However, this still hasn't happened and it isn't clear there is a true incentive for the regulator to do this.
The company also still has some pending lawsuits (mentioned in the previous article) and no real resolution on those. The only real change was the fact that CCI had a much lower operating loss and one that was more consistent as compared to other time frames. Even so, it is still very difficult to know the true worst case scenario for CCI, and that is probably the most difficult part of the valuation process.
Again, I won't go into great detail on the valuation as that is all covered in the previous article, but in general I would keep my valuation at $9.30 per share. Even with the improved CCI performance I still find it difficult to know what to expect on an annual basis. Additionally, I still don't see the information needed in order to really decide on a worst case scenario with CCI. I will continue to keep the assumption that the MI segment is walled off and won't result in any new capital requirements and I continue to believe the company can navigate any potential debt covenant violations.
The only slight upside I see is if CCI continues to have operating losses in the $6M to $7M range on a quarterly basis, I would probably give a slight increase to the valuation. Assuming CCI continues in that range the dividend should still be covered by the core operating results, which hopefully will get back on a growth track. The net operating income per share for the core operations (General Insurance, Title, and Corporate) was $.23, which even if you took away $.03 for CCI, still covers the dividend by a few cents. Again, as I have written before, it isn't a significant coverage margin, but it is covered none the less and hopefully these figures start to increase.