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Investment Thesis
Kinsale Capital Group (NYSE:KNSL) is a property and casualty insurance company that focuses on the excess and surplus (E&S) lines market in the U.S. I believe they present a great investment opportunity for a growth-oriented investor because:
1. Their business is rapidly growing (5 year average revenue growth of 39.52%), and this growth will continue into the foreseeable future.
2. Their proprietary technology provides an adequate economic moat, while their team brings a high level of expertise, allowing KNSL to achieve superior profitability compared to peers.
3. They are a financially disciplined company, and increasing leverage to target a higher goal of long-term growth will enhance the growth trajectory.
Rapidly growing business
KNSL is specialized in the E&S market where the risks are unique and hard to place in the standard insurance market. This market allows companies to underwrite non-standard risk with more flexible coverage and unregulated premium rates. The overall E&S market is growing faster than the standard insurance market as the business environment and society become increasingly complex, and KNSL's business in particular has grown rapidly over the past several years. Their revenue growth has been closing in on an average of 40% per year for the past 5 years, while EBIT growth (5 year average of 34.65%) and EPS growth (49.31% for the same duration) have been outstanding as well. Given that the overall E&S market is expected to grow at 8.3% CAGR for the foreseeable future, and KNSL is expected to continue to expand their market share within, I expect KNSL will maintain an aggressive growth trajectory in the foreseeable future. KNSL's revenue trend and overall surplus lines market trend are shown below.
Source: YCharts
Source: Slide from investor presentation
Economic moat by people and technology
KNSL has built a considerable economic moat around their business by leveraging the experience of their people and their proprietary technology. Their biggest asset lies in their people. Close to half (45%) of their liability examiners have a JD, and they have several former paralegals in their team. Also, the average experience level of the team is 14 years. Thanks to the team's deep expertise and knowledge, they are able to successfully balance their broad risk appetite by maintaining a diversified book of smaller accounts with strong pricing and well-defined coverages. Unlike many of their competitors, they do not extend their underwriting authority to third parties, which further demonstrates the company's dedication to the quality of their underwriting team.
Additionally, they also differentiate themselves through their utilization of technology. They have built a proprietary platform reflecting the experience and expertise of their management team, and the platform operates with a data warehouse of statistical data. The platform provides high efficiency, accuracy, and speed for their insurance operation (underwriting, pay out, investigation, and etc.). The economic moat created through the combination of people and technology allows them to maintain an attractive combined ratio (around 75%) and high profitability compared to peers. Their profitability metrics (EBIT margin, Net Income Margin, Return on Equity) are either above the peers or at the top of the range. A profitability table comparing these metrics is given below.
Source: Seeking Alpha
Strong balance sheet and financial strength
KNSL's management team is financially disciplined, and the company has a strong balance sheet. They have more cash ($90 M) than total debt ($42 M), and total debt to equity ratio lies at 6.5%, which is significantly lower than peers (ranging from 13% to 29%). This strong balance sheet demonstrates the financial discipline of the management team. AM Best rated KNSL's financial strength and long-term issuer credit as excellent, further demonstrating the company's financial strength. The rating history by AM Best is shown below. Additionally, during the last earnings call, management mentioned that their long term goal for the debt to total capital ratio is to approach 20%, and financial leverage will lift their growth trajectory.
Source: AM Best
Intrinsic Value Estimation
I used the DCF model to estimate the intrinsic value of KNSL. For the estimation, I utilized TTM operating cash flow ($375 M) and the WACC of 10% as the discount rate. For the base case, I assumed operating cash flow growth of 25% (sector median EBITDA growth) for the next 5 years and zero growth afterward (zero terminal growth). For the bullish and very bullish case, I assumed operating cash flow growth of 27% and 30%, respectively, for the next 5 years and zero growth afterward. Given that the most recent quarter's YoY revenue growth was 44%, I believe that 25-30% growth is readily achievable.
The estimation revealed that the market is currently undervaluing KNSL, and the current price represents 40-50% upside. Given the accelerated growth rate of the overall E&S market relative to the standard insurance market, and KNSL's economic moat, I expect KNSL will achieve this 40-50% upside.
Price Target | Upside | |
Base Case | $322.34 | 52% |
Bullish Case | $345.42 | 62% |
Very Bullish Case | $382.72 | 80% |
The assumptions and data used for the price target estimation are summarized below:
- WACC: 10%
- Operating Cash Flow Growth Rate: 25% (Base Case), 27% (Bullish Case), 30% (Very Bullish Case)
- Current operating cash flow: $375 M
- Current Stock Price: $212.6 (12/2/2021)
- Tax rate: 30%
Risk
The insurance business by nature is exposed to disasters (e.g., natural disasters or litigation), and large claims from such a disaster could bring financial difficulties. However, KNSL has a highly experienced management team and employees with deep expertise in underwriting E&S policies and managing the associated risk. Their proprietary platform with a sophisticated data analysis package also helps them manage risk effectively. One recent example was their loss associated with Hurricane Ida ($4.6 M). The loss was modest, considering the severity of the storm, and management mentioned that the risk was mitigated through a combination of good underwriting, avoiding concentration of business, and a comprehensive reinsurance program. I believe KNSL will continue to successfully manage their risks to maintain high margins and profitability in the foreseeable future.
Conclusion
I believe KNSL presents a great investment opportunity for a growth oriented investor. They are in the rapidly growing segment (E&S) of the insurance market, and their highly experienced people and technology have allowed them to achieve superior growth and profitability. Given their financial strength and the quality decision-making skills of their management, I believe they will be able to maintain their rapid growth trajectory. While large claims from natural disasters or litigation can introduce challenges, I believe KNSL has an effective risk management system in place to mitigate these losses. I expect 40-50% upside from the current price level.
