Universal Insurance Holdings, Inc.: High Risk, High Reward

| About: Universal Insurance (UVE)
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Summary

UVE combines rapid growth with a cheap valuation.

The low payout ratio makes it a strong dividend play.

A strong balance sheet and recent efforts to diversify help mitigate hurricane risk.

Down nearly 20% in 2017, now may be a good time to buy in.

Using value investing guidelines as a filter, I have found Universal Insurance Holding, Inc. (NYSEMKT:UVE) to be an undervalued growth company with stellar fundamentals and exceptional potential as a high-yield stock. However, its large presence in Florida exposes it to substantial hurricane risk.

UVE's fundamentals are very strong with consistently stellar ROE - averaging above 35% over the past 4 years. Since 2011, revenue has more than tripled, net income has grown nearly 5 times, and earnings per share has grown over 5.5 times. Incredibly, book value per share has nearly doubled over the past two years. In addition to strong profitability, the company is also conservatively financed as evidenced by its debt/equity ratio of 0.04.

The current purchase price of $22.85 appears generally undervalued when weighed against several valuation metrics:

P/B

P/E

P/S

P/CF

UVE

2.2

8.2

1.2

6.7

UVE - 5-year average

2.3

8.5

1.4

5.5

Industry

1.4

16.6

1.3

9.5

S&P 500

3.0

21.3

2.1

13.1

Additional valuation models (Jitta (fair value of $43.8) and GuruFocus (Peter Lynch fair value of $69.5, and DCF fair value of $70.55)) further indicate undervaluation. Given the risk of a severe hurricane wiping out profits and even producing substantial losses on any given year, my own DCF analysis assumes no future earnings growth and a 15% discount rate, yielding a valuation of $29.12, making it undervalued by 22% at current levels.

UVE is also a sound long-term dividend play. Its dividend currently stands at a healthy 2.45%, its payment has increased more than 300% since 2011, and has enormous growth potential with only a 16.7% payout ratio in 2016.

Another factor that makes this company an attractive investment is its vision for continued growth and diversification outside of Florida in order to fortify its profitability by reducing hurricane risk. The company is now licensed to issue insurance policies in 19 states, after the recent addition of Iowa, representing ~21% of its total insured value. In its latest annual report, Universal Insurance outlined its five-point strategy for achieving its diversification vision for growth: (1) "Increase our Policies in-Force in Florida through Continued Profitable and Organic Growth" (2) "Increase our Policies in-Force Outside of Florida to Grow Profitably and Diversify Revenue and Risk" (3) "Optimize our Reinsurance Program as our Risk Profile Changes" (4) "Superior Claims Operations" and (5) "Continue to Provide High Quality Service through our Vertically Integrated Structure."

They believe this strategy will be effective due to their competitive strengths. First, the firm - led by CEO Sean Downes (25 years of industry experience) - possesses experienced leadership with a long history in the Florida personal residential insurance market, including successful navigation of Florida hurricanes. Second, their focus on underwriting discipline:

"We seek to consistently generate an underwriting profit on the business we write in hard and soft markets through carefully developed underwriting guidelines informed by our experience in evaluating risks and in handling and processing claims, which enable us to set prices relative to the risk we are assuming."

Third, the firm has robust internal capabilities:

"We are vertically integrated with substantially all aspects of insurance underwriting, policy issuance, general administration and claims processing and settlement performed internally. Our ability to provide these services ourselves allows us to compress the cycle time of claim resolution in order to promptly pay valid claims and to control claims handling costs … We also believe our model provides a superior level of customer service for our policyholders, enhancing our reputation and increasing the likelihood that our policyholders will renew their policies with us. Our monthly weighted average renewal retention rate for 2016 was 88.1%. We believe that when policyholders have high levels of customer satisfaction with our company, we are able to strengthen our reputation and relationships with our independent insurance agent network."

Finally, UVE's strong independent agent distribution network:

"We have developed long-term relationships with a network of approximately 8,600 licensed independent insurance agents … Our relationships … are critical to our success in growing our business in the future and are key differentiators when compared with competitors that have relied upon assumptions of policies from Citizens for their growth and … may not have developed the same degree of loyalty with as large a group of independent agents in Florida. We believe we have been able to build this network due to our reputation, commitment to the Florida market, experience, and integrity in the underwriting process, as well as our consistency in offering our products through hard and soft markets. Further, the responsiveness of our operating units due to our vertically integrated structure enhances our relationships with our independent agents."

Though the risk of a major hurricane causing widespread damage throughout Florida is real, the recent growth and profitability of UVE combined with its cheap price and strong competitive position make it worthy of consideration by value, growth, and dividend investors. Due to the extensive risk, however, I would limit exposure to the company to no more than 10% of a portfolio.

Disclosure: I am/we are long UVE.

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.