When we last covered AXIS Capital (NYSE:AXS) we had a bullish view on the company. This was based on a number of fundamental factors and a rather buoyant insider sentiment. We update our views today and tell you why you should look for a buying opportunity post Q1-2021 results.
A Brief Overview
AXS is a mid-sized global insurance and reinsurance provider.
Source: AXS Presentation
In 2020, the insurance segment made up about two-thirds of the total policies underwritten. The business is well diversified across multiple different segments.
Source: AXS Presentation
The insurance and reinsurance businesses are volatile by their very nature and the last few years have definitely not been kind to the underwriters. AXS has been strategically repositioning its portfolio overtime to try and reduce earnings volatility.
Source: AXS Presentation
This is beginning to show up in its loss ratios. The data shown below is excluding the catastrophe segment, an area that is much harder to control for.
Source: AXS Presentation
Underlying loss ratios in insurance have also shown modest improvements over time. These again are excluding the catastrophe segment.
Source: AXS Presentation
Our Positioning
When we last covered this stock, we had good exposure to this company via Cash Secured Puts.
Source: Author's App
Our rationale for playing it this way was because we wanted to earn a high current income and get paid to own the stock at a favorable valuation. In other words, we were writing insurance on a top-quality insurance underwriter.
Why We Exited
Following the epic Texas storm that caused unprecedented damage, we reconsidered the upside of staying involved with the stock. We had already captured the bulk of the premium and the risk was increasing that AXS would preannounce Q1-2021 loss estimates. Fitch expects total insured losses in the range of $10-$20 billion for the industry.
U.S. property/casualty insurers are expected to face record 1Q21 catastrophic losses due to extensive property damage from last week’s severe winter weather in Texas, Louisiana and other southern states. Extremely cold temperatures and ice are generating hundreds of thousands of claims from frozen/burst pipes, roof damage, power outages and lost business income that will pressure near-term insurer results. However, losses are likely most concentrated within large homeowners writers that have effective claims resources and are well capitalized to absorb short-term volatility from outsized catastrophic events, Fitch Ratings says. Texas has 4.9 million homeowners’ policies with over $10 billion in annual written premiums, according to the Texas Insurance Department. Catastrophe losses tied to storms in southern states are expected to materialize from homeowners and auto business and various commercial insurance coverages. The widespread scale and claims volume of the event could drive ultimate insured losses to a range of $10 billion to $20 billion. As a point of reference, U.S. industry first-quarter catastrophe losses have averaged $4.6 billion over the prior 10 years, with a high of $7.6 billion in 2017.
Source: Fitch
Catastrophe modeling agency Karen Clark & Co. has estimated insured losses from the storm at $18 billion. Some other estimates are even higher.
Of his $80 billion to $90 billion estimate for direct and indirect losses, there will probably be about $35 billion in physical damages, such as water damage from burst pipes. Of that, about $20 billion will be covered by insurance.
Source: Insurance Journal
We are leaning towards the high-end of those estimates. Now AXS is notably absent in the top 10 insurers from the impacted area.
Source: Fitch
But AXS does have good exposure to Texas and the hurricane-heavy Q3-20217 saw AXS get hit with about $600 million of pre-tax losses.
Source: Business Wire
Hence, we expect the net impact to be significant. Now, this does happen with insurance plays. That is part and parcel of the low multiple that you get in this industry. But what is concerning here is that earnings estimates have moved just a shade lower.
2021 estimates have gone from $4.48 per share at the end of February 2021 to just $4.32 today. To put this in net income terms, estimates have shifted to about $15 million in net income (4% of annual estimated earnings). We wholeheartedly disagree with this assessment and it stands in a different dimension compared to the losses AXS had in Q3-2017. We closed out our positions and made good income on the play.
Source: Author's App
What To Do Next?
Let's get this part straight. AXS did not do anything wrong here. Neither is the fundamental story for higher pricing across multiple insurance segments changing any time soon.
Source: AXS Presentation
But we are seeing a rather big mismatch between our estimates and the street. Now, this might be out of sheer laziness in getting updated numbers in, but it does not change the fact there might be a big negative surprise looming. We are also concerned that the market may lose patience with AXS in particular as this Q1-2021 loss will come after a rather difficult 2020. Hence we are downgrading this to a neutral. AXS will announce its Q1-2021 results soon and that alongside a shift in sentiment in the general market will set us up nicely for another round of high-income options. We are waiting patiently until then.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
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