NI Holdings - Bet The Farm On This Crop Insurer

by: Edge Lab

Summary

NI Holdings is trading at 60% of book value despite being the largest domestic property and casualty insurer in North Dakota and scoring an “A” rating by A.M. Best.

NI Holdings generated $17M of operating cash flow in 2015 and has achieved an underwriting profit for 11 of the past 12 years.

Asymmetric risk/reward due to the mispricing inherent in the mutual conversion process. 60% price appreciation is possible as company deploys capital from the conversion and gains visibility with investors.

Thesis

NI Holdings (NASDAQ:NODK) is a intermediate holding company which owns 100% of Nodak Insurance Company, formally Nodak Mutual. The company recently completed a private mutual insurance company to a public stock insurance company conversion by selling 45% of its 23M shares to its policyholders, employees, management and the public at $10 per share. The remaining 55% of the shares outstanding are non-economic and owned by Nodak Mutual Group, Inc. which acts as the Mutual Holding Company or MHC.

The corporate structure is shown below:

Investor enthusiasm for this stock was evidenced by the significant oversubscription to the conversion subscription; $250M worth of stock was requested by investors for the $103M maximum amount of stock offered. The fortunate investors who received the $10 stock from the conversion subscription saw their investment pop 40% on the first tick as the stock began trading around $14 on March 16.

At the time of this writing, the last quote of $14.90 is still significantly below the $24 book value and significantly below peer valuations. As the proceeds from the conversion are deployed and investors become aware of the company and the mispricing, the stock should trade much closer to peer multiples, which implies share appreciation of around 60%.

Why does the opportunity exist?

There are three factors at play causing the mispricing.

1. The independent valuation firm hired by NI Holdings discounted the company's price to book valuation relative to the peer group simply because almost 40% of its post conversion book value will be the cash conversion proceeds. Cash doesn't yield much and so it discounted the price to book multiple by 40%. This will be remedied once the cash is deployed and is generating earnings.

2. The mutual conversion process and Mutual Holding Company structure can create mispricings due to the fact the 55% of the shares held by the MHC are non-economic - meaning they have not been sold by the company. However, these non-economic shares are still counted in the shares outstanding. The company sold 10.3M shares, but has 23M shares outstanding. When the independent valuation firm calculated the fair per share valuation, it used the whole 23M shares. In reality, only 10.3M shares were sold and the remaining 12.7M can be sold at a later date without increasing the shares outstanding. If and when these shares are sold, it would create another catalyst for growth that is beyond the scope of the thesis presented here.

3. The company quietly went public via the mutual conversion process. There was no road show. There were no high paid investment bankers promoting the stock. There were a few articles in local newspapers and the SEC filings. That's it. Very few investors know about this stock. The few who do know were very enthusiastic as evidenced by the conversion oversubscription and the $14 opening tick.

Company Background

Nodak Mutual was formed in 1946 to offer property and casualty insurance to members of the North Dakota Farm Bureau. In fact, the company shares an office building in Fargo, North Dakota, with the North Dakota Farm Bureau as shown in the photograph below:

The company has grown to be the largest domestic property and casualty insurer in North Dakota with a 5.4% share of the $2.4B market in North Dakota with total revenues of $146M and 126 employees. Revenue grew by 6% in 2015 and net income grew 17% while generating $17M in operating cash flow.

The company is led by CEO Jim Alexander, age 50, who has been with Nodak since 2003 and has 25 years of experience in property and casualty insurance.

Given the sensitivity of its business to weather, its ability to achieve profitable underwriting for 11 of the past 12 years is impressive. This is evidenced by the "combined ratio" being less than 100% for 11 of the past 12 years. This is reinforced by a statement in the prospectus regarding how it set pricing:

"If our pricing strategy cannot yield sufficient premium to cover our costs on a particular type of risk, we may determine not to underwrite that risk. It is our philosophy not to sacrifice profitability for premium growth."

In addition to conservative underwriting, the management team is focused on keeping costs low, as evidenced by an expense ratio of 26.2% versus the peer average of 31.2%.

The segment breakdown of the revenue is as follows:

  • Personal auto, home and farm policies - 62%
  • Crop insurance - 29%
  • Non-standard auto insurance - 6%
  • Commercial insurance - 3%

Growth Strategy

The company stated in the prospectus it will use the $91.7M conversion proceeds to expand geographically, principally into South Dakota, to acquire a commercial underwriter and to add capacity to underwrite more policies.

It is currently the 88th largest underwriter in the $2.4B South Dakota market and so there is plenty of room for growth.

The company's commercial underwriting premium revenue is only 3% of the total premium revenue. By acquiring a commercial underwriter, it can diversify from its 62% personal underwriting premium revenue percentage.

Management M&A Experience

The key members of the management team presided over two acquisitions. The company acquired control of Battle Creek in 2011, a mutual insurance company in Nebraska with 2015 premiums of $20.7M. In 2014, the company acquired Primero Insurance Company, an auto insurance company in Nevada with 2015 premiums of $11.3M.

Valuation

The prospectus provided the below peer comparables:

Following the conversion, the company expects to add $91.7M from the conversion proceeds to the existing $155M book value for a new total book value of $246.8M. If the company can fruitfully deploy the conversion capital, it should be able to achieve the peer group median price to book valuation multiple. The peer group median price to book is 101.3%. Applying this multiple to the $246.8M yields a valuation of $250M.

Given that only 10.3M shares were sold, the actual book value per share is $250M/10.3M = $24.15 per share. Given the last trading price of $14.9, this would yield a gain of 62%.

Concerns and Risks

M&A Risk

The company's whole reason for the mutual to stock conversion was to enable growth through acquisitions. If the management team is not able to find targets at attractive valuations or it executes poorly, the cash raised from the conversion may not add to earnings as expected. I don't expect this to be the case - but it is a risk.

USDA Budget Cuts

Crop insurance premiums were 29% of the company's total premiums for 2015. The crop insurance premiums are subsidized by the USDA's Risk Management Agency. The 2018 budget recently proposed by President Trump calls for a 21% decrease in the USDA's budget. There is nothing mentioned in the proposed budget about cutting the crop insurance budget, and I don't think it is likely to be cut due to the strong farm lobby. However, if the crop insurance program is cut, it would likely reduce demand for the insurance due to the increased premiums.

Rising Interest Rates

The company invests the premiums it receives primarily in debt instruments which may decline in value as interests rates rise. However, in the longer term, rising interest rates will boost the yield and earnings of the company.

Weather

The company's earnings could be materially reduced by significant weather events such as severe flooding, fires, etc. However, the company has achieved underwriting profits for 11 of the past 12 years.

Catalysts and Conclusion

NI Holdings is significantly mispriced due to coming to market via the mutual conversion process and due to lack of investor awareness. If management is able to successfully deploy the funds raised from the conversion, the stock price will likely approach $24 based on the median peer multiples.

As the stock begins to show up on stock screeners, investor awareness will increase and will further drive the price toward peer multiples.

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Disclosure: I am/we are long NODK.

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.