CNA Financial: A 6% Implied Yielder

| About: CNA Financial (CNA)


CNA is one of the largest P&C commercial insurance companies in the U.S.

As CNA pays a special dividend every year for four years now, the dividend yield is currently around 6%.

Every dividend-oriented investor faces the following age-old questions: Is it undervalued as well? Is the dividend sustainable?

Let's try clarifying the situation as much as possible. Take a deep breath and enjoy the reading.

Note for the readers: Most of the figures are based on financial reports of CNA Financial Corporation (NYSE:CNA)

CNA At A Glance

CNA is the 8th largest U.S. commercial property and casualty insurance company. Founded in 1897, CNA has approximately 6,500 employees, serving businesses and professionals in the U.S., Canada, Europe and Asia.

Source: CNA's Financial Presentation

In 2016, the company generated $9.4 billion of revenues and a net operating income of $824 million, mainly supported by an excellent combined ratio of 95.9%.

Source: CNA's Financial Presentation

The most substantial part of the revenues comes from the U.S., as approximately 7.9% of the direct written premiums were derived from outside of the United States in 2016 (vs. 8.0% and 8.8% in 2015 and 2014 respectively).

Source: CNA's 2016 Annual Report

Last but not least, 90% of CNA's outstanding shares are owned by Loews Corporation (Loews) (NYSE:L).

Source: Loews' 2017 Financial Presentation

Loews owns others publicly traded and non-publicly traded companies as well, like Diamond Offshore (DO), Boardwalk (BWP), Loews Hotel or Consolidated Container Company. A full article could be written on this conglomerate and even on the Tisch family. I will not go further and concentrate my efforts on CNA.

An Operating Performance Driven By The Specialty Insurance Portfolio

When you look at the five-year history, there are at least two points which deserve to be mentioned. First of all the revenues were stable over the period while many investors expect the revenues to grow every year.

Source: CNA's 2017 Q3 Presentation

As I said many times, it is better to have a non-growing insurance company with high margins instead of an insurer which increases its revenues by 10% every year but by deteriorating its underwriting performance.

Regarding the underwriting performance observed from the last five years, the five-year average combined ratio amounts to 98.6%. However, it is important to note that 2012 was an awful year regarding the profitability as the combined ratio deteriorated to 105.9%. Since 2013, the combined ratio was below 98%, and improving almost every year to reach 95.9% in 2016. Proof of the underwriting discipline of the company, the year-to-date combined ratio of the P&C operations was 98.2%, in spite of the catastrophe losses reported in Q3 2017.

Source: CNA's 2017 Q3 Presentation

How did CNA succeed to deliver a year-to-date positive performance? The reason is simple; CNA's portfolio is well-diversified and has a hidden gem: its specialty insurance portfolio.

Source: CNA's 2016 Annual Report

It represents around one-third of the total earned premiums but generates approximately 79% of the net operating income. Why? Because the portfolio is well-managed, highly profitable and focused on niche markets, like surety business, healthcare insurance segment, or the alternative risks. With a combined ratio of around 87%, nobody can deny it: it is very profitable from an underwriting performance point of view.

It is less the case for the two other segments: the commercial business and the international activities. Let's talk firstly about the commercial insurance activities. I must admit it is not so good when you look at the past.

Source: CNA's 2016 Annual Report

The combined ratio was higher than 100% in 2014, 2015 and 2016, and the situation will probably not change in 2017, unfortunately. Why? Because the commercial portfolio has been adversely affected by the catastrophes.

Source: CNA's 2017 Q3 Presentation

The abroad picture looks slightly better. With a three-year average combined ratio of around 96.4%, the performance of the international activities is correct.

Source: CNA's 2016 Annual Report

As for the commercial segment, 2017 results will be under the sign of the catastrophe impacts. In Q3 2017, the catastrophe losses contributed 27.5 percentage points to the 125.9% combined ratio. One year ago, the catastrophe losses represented only 1.5 percentage points of the combined ratio.

Source: CNA's 2017 Q3 Presentation

I now come to my second point; in spite of stable revenues, both operating income and net income are erratic. The saw-tooth results over the years are mainly related to the underwriting performance. When the commercial segment-related losses are contained, then the underwriting performance is good. If the international activities are well performing as well, then the underwriting performance is excellent.

Do not take me wrong; I do not say that the company is not well managed. The insurance reserves are stable over the years, and the management is not too aggressive to release reserves attached to previous years to boost the technical results.

Source: CNA's 2016 Annual Report

And it is readable in the reported figures. Every year, the company succeeds to deliver a positive run-off at the overall P&C operations level.

Source: CNA's 2016 Annual Report

You do not trust me, don't you? Look at the past then.

Source: CNA's 2013 Annual Report

I know that we never blindly trust the past, especially when we want to project the future. But at least, the past gives you a good indication of how the company is run. For CNA, I can say that the company is correctly managed.

When "Special" Becomes "Regular"

When a guy titled in one of its article "A 6% Yielder" or some similar catchy headline, everyone wants to see a big part of the article dedicated to this dividend story. Calm down guys; it is arriving; Rome was not built in a day.

From 2007 to 2017, the paid dividend increased by 785%. Hold on, don't be too euphoric, and let's have a look more deeply at the facts. Yes, the dividend increased by 785%, but the company did not pay dividends in 2009 and 2010. Furthermore, the dividend paid in 2015 and 2016 was stable. Last but not least, the management has taken the habit to declare a special dividend every year since 2014.

Source: CNA's website

With a $1.1 per share regular dividend, the payout ratio is 56.60%, and the current dividend yield is 2.21%. If the $2 per share special dividend is maintained next year, the FY 2018 paid dividend will be $3.2 per share. If the quarterly dividend is increased by $0.05 per share in the middle of next year, the dividend could even grow to $3.3 per share. By considering the special dividend as not so special, the current dividend yield jumps to 5.7%. Then the 2018 forward yield would be between 6.0% and 6.1% if we consider that the $2 per share special dividend will be maintained next year.

The next question is: Is the dividend sustainable? I would say it depends on many factors. The first one is the operating performance of the company. In 2017, CNA will be affected by catastrophes and the FY 2017 earnings will be indeed at the same level than in 2016 or even slightly lower. If the earnings per share will amount to $3.17, the overall payout will be 97.7% in 2017.

It means that it will be difficult for the company to increase the regular dividend significantly in 2018. I have the feeling that the market and the analysts have now taken the habit to consider that the $2 per share special dividend is quite regular. Hence cutting it will send the wrong message to the investors. That's why it will be certainly maintained in 2018. With a $1.2 per share regular dividend and a $2 per share special dividend, it means that the earnings per share should at least reach $3.2 to avoid having a disastrous effect on the book value.

In my view, the dividend policy of CNA is entirely dependent on Loews' one. For paying a dividend to its shareholders, the holding should receive money from its subsidiaries.

Loews' Q3 Financial Presentation

I do not say Loews pumps all the money from its subsidiaries. But at least it needs cash to pay its shareholders. As CNA represents the largest contributor, it is normal that CNA delivers recurring and increasing dividends.

No Share Repurchases: A Sign Of Wise Management?

Neither in 2015 nor 2016 shares have been repurchased. In fact, the level of outstanding shares remains remarkably stable over the year (around 270 million). Sometimes, investors say that repurchasing shares is the sign of a wise management because money is redistributing to the shareholders. Other investors could mention that avoiding repurchasing shares could also be the sign of a prudent management because the company considers that it would destroy value instead of creating it. In the case of CNA, I guess it is only because Loews does not want to increase its stake in the insurance company and prefers receiving the cash directly through the paid dividends.

A Forward 6% Yield, A Well-Managed Company, Is It A "Go" To Purchase CNA?

Don't put words in my mouth. I never say that CNA is the bargain of the century or even of the decade. The five-year average P/B ratio is around 0.8-0.9. Currently, with a book value per share of $44.88, the stock is traded at 1.2 times the book value. In my view, it remains expensive, and I have the feeling (without having dug into all the details) that investing in Loews could be more rewarding than CNA.

Notes for the readers: Interested in other analyses mainly focused on the insurance sector? Please do not hesitate to follow me. Thanks a lot for your support! Furthermore, I will be more than happy to discuss with you on my articles, the chosen assumptions for valuing companies' intrinsic value or anything else you consider as relevant.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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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