We've highlighted 1347 Property Insurance (NASDAQ:PIH) as a small but fast-growing property insurance business in the state of Louisiana. Our top idea and follow-up were predicated on the strong expansion opportunity and the cheap valuation from the "busted IPO" over a year ago. Shares have not moved in the 18 months since going public but we still believe that the shares are deeply undervalued.
In addition, we think activism in the shares is on the mend as they cut ties with Joseph Stilwell earlier this year and Legion Partners has a large stake in the business. The core business remains on track to achieve the 2% to 3% penetration in the Louisiana market but the recent entry into Texas is likely the game-changer needed to significantly ramp revenues.
Growth Targets Being Achieved
When 1347 went public, they stated that their medium-term objective was to reach 2% to 3% of the Louisiana homeowners market. This was to be achieved by taking advantage of the pullback by the larger players following Katrina and other large storms afflicting the state. In addition, they hoped to utilize their expertise in the state with long-standing relationships with the top independent agents. The company is now a top writer of property insurance in the market and are well on their way to achieving their goal.
The localized proficiency of the Gulf Coast market should continue to allow them to capture share through better pricing and margins. Over the last three years, they have written over 25K policies growing over 100% per year since they started in late 2012. While this number appears low, it is difficult to gain share in this market, as consumers tend to only shop for new property insurance when they move or after a weather event that pushes up rates in the area.
During the third quarter, the company did experience a higher severity of claims due to second quarter weather-related events. A single event that occurred in the last week of April in Louisiana, developed from just under $1.5 million to just under $2 million in claims by the end of the third quarter. Other weather-related events accounted for $1.1 million with non-weather related claims at $1.6 million- most of which was fire losses. As a result, their net loss ratio was 51.9% compared to 21.3% a year ago. The losses they experienced did not reach the threshold of their catastrophic reinsurance structure.
They have now expanded their geographic presence to 63 of the 64 parishes in the state, which has allowed them to increase gross premiums written by 39.1% to $11.8 million from $8.5 million the year before. This growth is key to their maturing as a property insurer. The market is still clearly focused squarely on the loss ratio, which was again higher, at approximately 52%. This helped push up the combined ratio to 103.5% compared to 78.7% in the year ago quarter. A ratio above 100% means they are writing unprofitable policies.
But given the amount of weather and non-weather related claims, to be just above the 100% mark speaks to the skill of the management team and underwriting process. The combined ratio should fall back down to below 90% in the fourth quarter given the rolloff of some of these claims from the second quarter along with new business. The industry's normalized combined ratio is just above 90 for the last several years but 1347 has been able to keep theirs substantially lower. Excluding the claim development from the weather events of the second quarter, the combined ratio would have been 79.8%.
Our basis for the drop is the historical precedent of the company's results. The company typically sees stronger claim data in the second quarter due to seasonal weather patterns. In the second quarter of 2013, the combined ratio hit 190.1%. In the subsequent quarter, it was down to 118%, a drop of 37%. By the third quarter of 2014, the ratio was down to 78.7%. In 2014, they didn't see any spike in the combined ratio like they have in 2015 and 2013. Both events are not out of the norm but are not going to be recurring every month either- statistically speaking.
We see the combined ratio, barring any large storms in the state during the quarter, falling and helping to drive back up profitability. In addition, as reinsurance rates continue to fall, it should present the company with the opportunity to either reduce risks by lowering the reinsurance activation threshold or increase margins on the lower annual expense to insure the same given level of risk. The fourth quarter is typically seasonally quiet - except when a 1-in-100 storm hits (think Katrina).
In addition, Citizens in Louisiana is in depopulation mode following the re-growth of the industry in the state. The Citizens take-out program occurs annually in December and we think 1347 will be a prime buyer in 2015. Much of these policies are coastal and the company now has a complete presence on the coastal communities meaning they could be large acquirers compared to years past. In addition, the large players including State Farm and Allstate continue to exit the coastal areas.
Brotherhood Mutual Alliance Gains Them Entry To Texas Market
Our thesis a year ago noted their potential to grow into adjacent geographic markets with Texas and Florida being natural extensions. In May of this year, they gained approval from Texas state regulators to operate within the state. The company began assuming commercial wind/hail only risks in the state through their Brotherhood Mutual alliance and on the personal line side organically. As of the third quarter, they have just two products, their manufactured home product and a wind and hail-only product. Their traditional homeowners product should be available for sale in the next couple of weeks and their dwelling fire product by year-end.
In the meantime, they are in the process of signing up agents to their independent agency network. As of the quarterly conference call earlier this month, they had over 100 agents on the network. As they ramp up the resources behind growing that number, and as they start offering the full complement of products, we see Texas becoming their key market over the coming years. Texas has four times the number of households and five times the amount of direct premiums written allowing a much larger market opportunity. It is also a much faster-growing market growing at a four-year CAGR of nearly 6% compared to ~2% growth.
During the summer, the company partnered with Brotherhood Mutual to offer wind/hail coverage in the state. Under the partnership, 1347's insurance subsidiary, Maison Insurance Co., will write supplemental wind and hail policies in alliance with Brotherhood's commercial multi-peril policy platform for policyholders in Texas. Starting in June, Maison began covering risks associated with select policy renewals in collaboration with Brotherhood Mutual.
We think this is the first of many partnerships that are to come as they look to ramp up in the state. CEO Doug Raucy also noted that they are looking at some expansion opportunities including the ability to deploy capital for inorganic growth. We think that they could execute on some potential M&A activity by the end of next year.
(Source: Investor Presentation)
The valuation remains extraordinarily cheap as the multiple headwinds in the name combine to depress investor sentiment. We noted that cessation of the Management Services Agreement with 1347 Advisors, a Kingsway affiliate. The termination of the agreement, which stipulated that 1347 Property would pay the affiliate a perpetual payment of 1% of all premiums held simply for advice. The cost of the termination is a short-term hit to profitability but over the long term given the ramp in the number of policies, we think this will be a major positive. Other negatives include the second quarter storm claim, which has swung the company to a net loss position.
The fourth quarter should see loss ratios return to their normalized levels even though costs associated with the ramp in Texas are likely to pressure margins near term. The higher costs will be partially offset by continued declines in reinsurance rates with industry experts expecting another 7.5% decline. Our normalized valuation expects low core loss rates despite what amounts to one of the highest overall property insurance rates in the nation. This allows for low loss costs and low attritional loss ratios. Combine this with the de-population of Citizen creating a favorable regulatory environment and we think loss ratios are likely to trend lower.
We compared the company to their peer group as the shares trading at 1.0x book to us appeared cheap. We attempted to find regional players with small market caps in order to get the comps correct.
The group has an average P/B just over 2x, which would imply a price of approximately $15 per share. We think book value can grow from ~$7.70 by 12% per year on ROE of between 10% and 15% based on management objectives - we think the bull case may be in excess of 15% given lower loss ratios and reinsurance rates. ROE was approximately 6.3% last year ($3.15 million on $49 million of equity). Given the growth in their book of business, they should have no trouble achieving at least 10% ROE over the next year and 15% long term.
Our forecasted 2017 book value is $9.65, which at 1.3x equates to a value of $12.55, for upside of 63% over the next twelve months. Even without any multiple growth, which we think is a low probability given the geographic diversification that is ongoing, growth should be 25% over the next year.
Legion Partners continues to have a large stake in the shares and recently added new board members to the company's board of directors. Given the lack of share price movement, we wouldn't be surprised if Legion becomes more aggressive in 2016 and submits more plans to management to unlock greater value.
1347 Property Insurance is a cheap play on a niche growth story within the insurance industry. The balance sheet is pristine with just $2.5 million in debt and $51 million in cash giving them the flexibility to grow rapidly both organically and inorganically. We think the shares could start to move higher over the next two quarters as loss ratios normalize and the company ramps up their Texas operations. We also think that eventually they will garner some sell-side coverage (though probably not until they reach $100m market cap) which could help improve the visibility of the shares.
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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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