Buy Homeowners Choice: 4.3% Dividend Yield, Massive Capital Appreciation Opportunity

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Homeowners Choice, Inc. (HCII)

Homeowners Choice is a micro-cap property and causality insurance company, with a market cap of $163.4mn, which provides its services primarily to Florida property owners. Founded in 2006, the company was listed in 2008 and has reported profits since then.

The company is benefiting from a combination of factors that have led its stock to reach 52-week highs, of which, Florida's weather leading to a diminishing competition in the region, its favorable market conditions, the company's comprehensive reinsurance catastrophe program, a strong growth in its market share, its solid financial position and the management's strong resolve to grow through an aggressive acquisition strategy, are but a few. Investors should be on the look for Homeowners Choice's future acquisitions, as these have the potential to increase its market share and share prices.

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Source: Google Finance

Florida has always been rocked with hurricanes, some of them quite severe. It has been slammed with more storms than any other state in the U.S., which is why annual preparations are carried out, where citizens make sure they are equipped with supplies that they might require during a hurricane. These storms have a direct impact on the local Insurance Industry, as they cause major damage to property. This is why big insurers have increasingly reduced their exposure to the region, causing smaller insurers to grab the market share. Homeowners Choice worked with the state to provide Floridians with insurance.

Florida's housing markets have seen improvements since the beginning of the year. Home prices in Florida, as represented by the Case-Shiller Home Price Index, are at 129.79, up from 128.02 in June and 128.73 a year ago. Privately owned housing starts authorized by building permits have seen improvements, as illustrated by the graph below. Number of foreclosures decreased from 26,758 in March, 2012, to 24,712 in April, 2012.

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Source: Ycharts

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The company, in order to mitigate the risk of devastating weather conditions where it operates, makes extensive use of reinsurance programs, whereby it pays premiums to other private insurance companies. As of June this year, the company reported total costs of $92mn for reinsurance programs. This cost would provide coverage as large as $549mn resulting from catastrophes.

The company has captured 2.8% of the market share, while the Florida market presents significant room for growth. The company is currently earning $235mn in annualized premiums, while the Florida market presents it with significant room to improve its premiums to $6.9b. The company has posted strong growth in earnings in all the 16 quarters for which it was listed. The company generated income of $7mn for the quarter ended March 31, 2012, up by 45% from the quarter ended December 31, 2012. Net premiums that the company was able to earn during 1Q2012 were $40.4mn compared to $16.7mn in 1Q2011. This is an increase of over 104%. At the same time, the company has been able to reduce its combined expense ratio from 100.7% in 1Q2011 to 75% in 1Q2012. With a return on asset of 8.8% and return on equity of 23.8%, the company offers an added advantage of 4.3% dividend yield. The high yield makes it very attractive to investors seeking regular income.

The management's strong resolve to capture a market share through acquisitions has paid off. Since the company is focusing on inorganic expansion, this has led to a decline in its marketing expenses. Homeowners Choice has, since 2007, assumed insurance policies from Florida's state sponsored insurer and other private insurers that provide the company with $235mn of persistent revenues. The acquisition of its major competitor, HomeWise, led to an increase of 70,000 insurance policies, representing $100mn in annualized premiums. This increase in the number of policies had actually doubled the size of the company's policies. To further strengthen their investment portfolio, the company acquired property at Treasure Island, Florida for approximately $8.1mn in 1Q2012.

Share prices have appreciated by 128% since the beginning of the year. Much of this appreciation is attributed to growth in profits due to the company's recent acquisition. The market have priced in the effect of the recent acquisition that the company made. One of the company's major competitors is Universal Insurance Holdings (UVE), whose stock is 6.4% down since the beginning of the year.

In conclusion, Florida, as far as the insurance industry is concerned, has been considered unprofitable for some time now, especially after the five Category 3 or above storms that hit the region in 2004 and 2005. While big insurers prefer to stay away from the region due to this devastating weather, Homeowners Choice has decided to pursue an aggressive acquisition based strategy to grow its market share in the region. Investors will see a surge in prices if the company is able to increase its market share by assuming more policies from its competition.

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