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Published: March 3, 2010
Insurance stocks often look like lousy
investments in a slow economy. Demand for policies can shrink as
unemployment rises, and rivals undercut each other on price to
snag whatever market share still remains. But you want to own
these stocks when the economy is still weak, as most investors
fail to appreciate the robust upside to come once unemployment
drops and competitors call a pricing truce.
Employers Holdings, Inc. (NYSE: EIG), which provides
workmen’s compensation insurance, looks like a classic
early-cycle insurance play. The stock is so unloved that it
trades at just 70% of book value, and sports a single-digit
earnings multiple on trailing earnings, even though those
earnings are at abnormally low levels. As earnings rebound, and
the stock’s
price-to-earnings (P/E) ratio expands, savvy investors may
be looking at a massive move up in its stock price.
Employers Holdings pulled off a well-received
IPO, at $525 million and $172 million, respectively.
Although the economy had not yet cooled yet, the insurance
pricing trends turned negative in 2007, dragging results lower
in 2007, 2008 and again in 2009. (Sales actually grew in 2009,
though only due to an acquisition completed earlier in the
year).
Net income, though, could not escape gravity’s pull in 2009, and
came in at just $83 million, less than half of the income
generated in 2006. Here’s the thing, though: Profits have been
trending down, but they are still quite robust. And that has
enabled management to keep doling out value to shareholders.
For starters, the company pays out a modest $0.24 annual
dividend, which translates to a yield of about 1.8%. More
important, Employers Holdings continues to buy back large blocks
of stock. The share count shrank from more than 50 million in
late 2007 to a recent 44 million. And thanks to the current
buyback, the share count could fall below 40 million by sometime
in 2011. The rising levels of cash have strengthened the balance
sheet, which when coupled with that shrinking share count, is
leading to an impressive spike in book value. In the most recent
year, book value per share rose +19%, to $20.67 from $17.43. At
the time of its IPO, shares traded above $20 and book value
stood at around $14 per share. Now, those numbers are reversed.
For shares to gain traction -- and move back up to book value
and beyond -- the company will need to reverse the recent sales
trends. If history is any guide, that should transpire in a
two-step fashion. First, a reduction in the unemployment rate
should boost demand for worker’s compensation policies. A year
or two later, insurance carriers should have ample room to start
raising prices again, which have been shrinking in recent years.
Both of those factors should help boost per share profits back
to around $1.40 in 2011, and perhaps above $2.00 in 2012.
Notably, per-share profits exceeded $2.00 in 2007 and 2008, and
soared above $3.00 back in 2006, the last time the cycle was
truly favorable. And that was with a notably higher share count,
so per share profits could set new peaks in the next cycle
Right now, investors will need to find solace in the steadily
rising book value, the rapidly shrinking share count, and an
unemployment rate that works its way slowly lower. As the cycle
turns, the reward should come from heady capital gains.
-- David Sterman
Contributor
StreetAuthority |
