Mercury General: Still No Growth, Still Nice Dividend

About: Mercury General Corporation (MCY)
by: Holmes Osborne

Sales are where they were in 2007.

The company receives most of its business in California.

The dividend yield is almost 5%.

Mercury General (MCY) used to be a high-flying auto insurance company. About a decade ago, the California market for insurers became saturated and the company's growth came to a halt. The stock pays a nice dividend but that's about it.

The stock trades for $50.82, there are 55.34 million shares, and the market cap is $2.8 billion. The dividend is $2.51 and the dividend yield is 4.94%. Earnings per share were $1.73 and the price to earnings ratio is 29.

Sales grew from $3 billion in 2014 to $3.4 billion last year. Nice growth, but unfortunately, income dropped from $178 million to $145 million over that time frame. Free cash flow was a whopping $322 million last year, so the stock trades at a free cash flow yield of 11.5%. Now that's impressive. I've seen posts in the past where people are concerned about dividend coverage. Believe me, it's safe with these cash flows.

The balance sheet is strong with $262 million in cash, $263 million in short-term investments, and $3.6 billion in investments. The liability side shows $373 million in debt and $1.8 billion in insurance liabilities. Strong balance sheet. Over 80% of the investment portfolio is fixed income. Perhaps income will increase with higher interest rates.

For the first nine months of the year, sales have increased from $2.388 billion last year to $2.5 billion this year. Unfortunately, income has dropped from $125 million to $76 million over that time frame. Mercury estimates that it will lose $37 million on the wildfires in Northern Californian. The combined ratio in the quarter was 95.6%, meaning that for every dollar of premium taken in, 95.6¢ were paid out in claims and expenses. A 6.9% rate increase for home insurance in California was filed in May. Insurers must receive permission from the Department of Insurance before raising rates. Mercury receives 77% of its premiums from California. This combined ratio is the lowest (which means best) ratio the company has produced in ten years. That's not good. Ideally, you'd like to have a combined ratio of this all the time.

I pulled up an Annual Report from 2007, about the time that our firm owned shares in the Mercury. The dividend was a little over $2 and the stock traded between $50 and $60. The stock price hasn't done anything in twelve years. Guess what sales were back then? $3 billion, same as 2016. Expenses have gone up though, what a surprise.

I used to be a huge bull on the stock. I bought right at the end of the growth train. I used to go to the Annual Meeting and would walk right up to management and talk to them. I remember that I asked what they were going to do to increase growth. They replied that they have new computers and that would make them more efficient. Anytime management tells you that, you should sell the stock.

The company was founded in the early 1960s by George Joseph. Joseph is the principal shareholder and is 97 years of age. Amazing. Joseph is still the Chairman of the Board.

So, is the stock a buy? Not really. The company has the same problem it did when we sold it - there's not growth. California is saturated with insurers and global warming makes the weather unpredictable. The dividend is nice and safe, but there are better investments out there.

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.