- Revenue growth has been strong due to organic growth and expansion into new markets, and that is expected to continue.
- The stock price has been constrained by the increase in costs due to weather-related claims hampering financial performance.
- Management is finding ways to mitigate these claims through price increases and expense rationalization and this could bolster the stock price.
Universal Insurance Holdings (NYSE:UVE) has been doing many things with a growing book of business and a solid balance sheet. The last two fiscal years have been rough due to weather-related claims (including fraudulent claims) in Florida - their largest market by any measure. This has hurt both profitability and valuation. Management has been trying to work through the claims through legal actions, reinsurance and price increases. UVE has been doing many things correctly to get out of this funk.
Revenue growth is great and has grown at a 11% clip over the last several years through organic growth and more recently through significant increases in pricing in Florida.
Source: UVE Investor Briefing
Management has been focusing on diversifying out of Florida to reduce the magnitude of claims on severe weather events. They have done a good job penetrating other states and Florida business has declined as a % of premiums in force. One problem is that the business in Florida keeps on growing.
Source: UVE 2020 10-K
To mitigate this risk, pricing in Florida has gone up double digits over the last two years and that trend is expected to continue. Steve Donaghy, CEO explains:
Despite the weather in 2020, we continued our focus on underwriting, increasing our primary rates in Florida close to 20% for the full year, including 7% in the fourth quarter for 2020 reinsurance costs, as well as increases in some of our Other States.
The main points are that management is pulling levers to improve the quality of the revenue by diversifying out of Florida and raising rates. Are these levers enough to mitigate the risk? I think Management is making strides to improve the quality of revenue. How do the Analysts feel about these strategies? Just from reading the Q&A and feeling out the cadence, I gather that the two Analysts on the calls have a comfort level with the revenue strategy and they are more focused further down the income statement.
The weather events in Florida the last two years have not been kind as the losses & loss adjustment expenses ratio as have climbed considerable and created a negative combined ratio. Whereas G&A expense ratio has declined over the years. This shows that management is finding other ways to improve profitability as they are managing controllable expenses. This operating leverage and increasing rates will help mitigate the rise in the combined ratio.
Source: 2020 10-K
At the bottom of the Combined Ratio table is the ROE (calculated as net income / average equity) to demonstrate profitability when the combined ratio is below 100%. Also, ROE is an important metric to measure profitability and for determining its valuation multiple. ROE of 4.1% in FY20 is a shadow of its former glory, but there is a bright side. Management is guiding for ROAE of 17%-19% in FY21 and this guidance is weather dependent. This would get financial performance closer to its glory days and I will go over how UVE can achieve those levels.
UVE has a strong balance sheet with solid liquidity with unrestricted cash of $167MM and a low debt-to-capital ratio of 1.8% and debt-to-equity of 1.9%. The strong balance sheet provides comfort to both UVE's customers and investors as this will help support a good credit rating. It shows they have the capacity to ride out the bad times and lever up if needed. This is another area where UVE prevails. The others were revenue growth and operating leverage.
Below is the guidance excerpt from the 4Q20 press release.
The guidance leads me to believe that they can continue on their growth trajectory, maintain operating leverage and improve their losses & loss adjustments. Part of the formula is maintaining cost discipline and demand for insurance remains steady. Any changes to these inputs coupled with weather concerns, would make these targets unobtainable. The main caveat - the guidance is weather dependent! Another bad weather and fraudulent year will obvious lower the guidance. Another way to look at it is that the weather-related loss adjustments still will be elevated when compared to the past. In other words, a 20%+ ROE may be at least another year out.
I made the following estimates:
The ROE and EPS was based on the assumption of$25MM in share repurchases at an average price of $14.50. All other income statement line items were kept in-line with the previous year or are within historical ranges.
I will add the disclaimer one more time: this is weather dependent. But, this is how the income statement might look to reach the guidance provided which I believe is reasonable.
Valuation & Stock Price
The table below compares UVE to its comparables.
Source: Each company's recent 10-K.
UVE's revenue growth is the strongest and its ROE lies somewhere in the middle. Its combined ratio also lies in the middle, but has the highest PB ratio. This tells me that investors believe that UVE has a favorable outlook and can grow its book value. Based on my estimates, the book value could increase to $506MM or a P/B of $16.74.
Historically, when the times were good, the PB was well over 1x due to high growth of its book value. For reasons mentioned numerous amounts of times already, the weather has caused book value to decrease. Investors were not interested in paying a premium for the Company.
Based on my estimates, book value would grow by 16% and if investors wanted to continue to value UVE at 1x PB, the target price would be $16-$17 per share. Given that the Company is still reactive to the weather events, that valuation may be optimistic. Right now, if the P/B was 0.85x, similar to its peer group, the stock price would be $14 share. Currently the stock is priced assuming that weather may still hamper financial performance and expense discipline remains intact. If the hurricane season is mild compared to the last two years and management's efforts continue, the stock could go closer to $17/share.
UVE has a lot going for it - strong revenue growth, solid balance sheet and an active management team. Management is working hard to mitigate the weather-related expenses through improving operations, increasing prices, maintaining a strong balance sheet, diversifying out of Florida and growing non-insurance revenue streams. Currently, the Company is valued that the book value will remain relatively unchanged from this past year. If the hurricane season is mild and operating expenses remain within recent historical range, the stock could appreciate to $17/share.
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