Third Point Re (NYSE:TPRE) reported first quarter net income of $50.5 million, with diluted earnings per share of $0.47. This beat analysts' expectations for earnings per share of $0.46. Gross written premiums for the first quarter of 2015 was $213.3 million, which significantly exceeded analysts' expectations by $69.6 million. Stronger earnings were the result of a strong investment performance in the quarter, where the net investment return on investments managed by Third Point LLC was 3.0%. The float increased by $161.6 million to total $597 million at the end of March 2015, which represents a significantly greater value of investments managed by Third Point LLC. This is why investment returns were significantly higher than the same period last year, even though the net investment return was very slightly higher last year, at 3.1%. Net investment income for the quarter was $64.9 million, compared to $50.0 million last year.
In particular, the structured credit portfolio performed strongly in the quarter, generating more than half of all investment returns. The performance of its equity investments were more mixed, with some positions in the Industrial & Commodities and Healthcare sectors making strong gains, whilst "moderate losses" were suffered in the Technology, Media and Telecommunications and Financials sectors. Nevertheless, its equity portfolio still produced positive investment returns of 3.7%. For comparison, the S&P 500 gained 0.4% over the same period, whilst the Dow declined by 0.3%.
The combination of the hedge fund style investment strategy and reinsurance underwriting business forms a total return business, which is likely to outperform the equity asset class during flat and bear equity markets. Since 2009, after the financial crisis, the investment returns of Third Point Re have significantly underperformed the S&P 500. But, the returns of a hedged investment strategy usually offers lower volatility and correlation to equity markets, leading to greater stability in investment returns. With equity valuations at relatively high levels since 2009, and as earnings for many S&P 500 stocks beginning to decline, a hedged investment strategy might finally outperform the equity index. This is all the more likely, if the dollar continues to strengthen, amidst tightening monetary policy in the US.
Although investment returns are usually of paramount importance for hedged fund backed reinsurers, underwriting forms a valuable component of profitability for what continues to resemble a reinsurance company. Third Point Re's experienced underwriting team and its improving underwriting performance have the potential to further expand the insurer's overall profitability. Firstly, underwriting profitability directly has an impact on the bottom line of the reinsurer. But also, sound underwriting can increase the value of the float, which is invested by its partner hedge fund, to further enhance returns on equity. The combined ratio improved to 102.8% in the first quarter of 2015, compared to 107.1% for the same period last year. A combined ratio greater than 100% represents an underwriting loss. Third Point Re has shown slow but steady progress with improving its underwriting profitability, and its combined ratio could fall below 100% this year, for the first time since its IPO.
Diluted book value per share, a measure of assets minus liabilities, increased by $0.42 over the past three months to $13.97. With a price to diluted book value of 1.00, I continue to be bullish with the stock. As I described in my March article on the reinsurer, the stock trades at a relatively low multiple on book value, as the consensus analysts' forecast implies that the insurer should generate a return on equity of around 15% over the next two years. Insurers earning a similar return on equity typically trade at around 1.2x book value or higher. With the potential for the combined ratio to fall below 100% for the first time, Third Point Re could trade at a similar valuation multiple.
Disclosure: The author is long TPRE.
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