Here’s a telling quote from Berkshire Hathaway CEO Warren Buffett, from his annual letter to shareholders late last month:
“Our insurance operations continued their delivery of costless capital that funds a myriad of other opportunities. This business produces “float” — money that doesn’t belong to us, but that we get to invest for Berkshire’s benefit. And if we pay out less in losses and expenses than we receive in premiums, we additionally earn an underwriting profit, meaning the float costs us less than nothing. Though we are sure to have underwriting losses from time to time, we’ve now had nine consecutive years of underwriting profits, totaling about $17 billion. Over the same nine years, our float increased from $41 billion to its current record of $70 billion. Insurance has been good to us.”
Indeed it has, over the very long term.
Three of the five names trade below tangible book value, according to Worldscope data supplied by Thomson Reuters, while only one — Berkshire — approaches a valuation of two times tangible book value.
Only one — again, Berkshire — trades above 10 times its consensus 2012 earnings estimate, among analysts polled by Thomson Reuters.
Three out of the five saw lower returns on equity (ROE) in 2011 than in 2010, with the flat yield curve in the prolonged low-rate environment taking its toll. Real Money contributor Roger Arnold, the chief economist for ALM Advisors, said on Wednesday that “declining U.S. sovereign bond yields and a shrinking spread between the fed funds rate and the 10-year Treasury yield indicates that profit margins of insurance companies’ float returns are under pressure.”
Arnold also pointed out that with the baby boomer population aging and “beyond the peak demographic age for purchasing life and health insurance,” demand for these insurance products is declining, and insurers are being forced to compete by lowering prices.
According to Arnold, the insurance industry “is caught between the proverbial rock and a hard place, as both premiums and returns on premiums are under pressure and look to be for many years.”
Of course, rates will not stay down forever, and long-term investors could be looking at bargains right here, after all, at the end of 2007, before the credit crisis, these names all traded at much higher multiples to tangible book value.
Gavin Magor, a senior financial analyst with Weiss Ratings, says that Arnold is absolutely right on interest rates, because property and casualty insurers make their money on investments, adding that “traditionally, P&C companies look to break even on the premiums and take the cash from the premiums to purchase investment securities. They are really struggling, especially when they are not breaking even on the underwriting business, because they got whacked from claims last year.
“Life insurers, on the other hand, are in it for the long term, typically buying bonds and holding them until maturity,” says Magor, who adds that this group “is not going to be ass affected by the low rates as P&C.”
Regarding the stock performance of the large insurers, Magor says the group “tends to lag behind the banks, even though the risk is actually lower than the banks.”
Magor’s bottom-line for investors is “an all-lines P&C insurer is not a good bet, but life is worth a look if undervalued and health is a gamble that could pay off big time if the company is large enough and the U.S. Supreme Court rules in the administration’s favor” when President Barack Obama’s health-care mandate is challenged.
TheStreet Ratings places its emphasis on long-term total returns, as well as revenue trends and capital strength and dividends, while also considering short-term performance, financial stability, and volatility.
Here are the five “buy”-rated insurance companies with the largest market capitalization , ordered by ascending upside, based on consensus price targets:
5. Berkshire Hathaway
Berkshire Hathaway’s class B shares closed at $78.87 Thursday, returning 3 percent year-to-date, following a 5 percent decline in 2011.
The shares trade for 1.9 times tangible book value, according to Worldscope data provided by Thomson Reuters, and for 15 times the consensus 2012 earnings estimate of $5.15 per class B share. The consensus 2013 earnings per share estimate is $5.45.
Berkshire Hathaway is, by far, the most expensive stock to tangible book value and forward earnings estimates among the five listed here, reflecting the long-term prominence of the company and its CEO, Warren Buffett.
Most of the media coverage of Buffett’s annual letter to shareholders last month focused on his announcement that the company’s board of directors was “enthusiastic about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire,” although neither the successor nor the “two superb back-up candidates” were identified.
One key investment made during 2011 that Buffett focused on in the letter were the $5 billion in Bank of America preferred shares purchased in September, which feature a lovely 6 percent coupon, along with warrants allowing Berkshire Hathaway to buy 700 million Bank of America common shares at $7.14 a share.
The warrants were in-the-money for $644 million as of Thursday’s close, but of course Buffett will be looking to make a much larger killing on this portion of Berkshire’s Bank of America investment.
Investors have been scratching their heads over this deal, since Bank of America said in its annual 10-K filing that “the related to Berkshire, increased Tier 1 common capital approximately $2.1 billion, or 15 bps,” which seems like small potatoes, in comparison to the potential bath Bank of America will take when Berkshire finally exercises the warrants.
KBW analyst Cliff Gallant rates Berkshire Hathaway “outperform,” with a $133,000 price target for the company’s class A shares.
Gallant said on March 2 that Berkshire’s GEICO subsidiary is over-reserved, expects the auto insurance subsidiary “to benefit from reserve releases” during 2012, but the unit’s profitability “has deteriorated materially as shown in loss ratio picks over the past six years, and particularly in (fourth quarter 2011) results.”
Barclays Capital analyst Jay Gelb has a “positive” rating on Berkshire Hathaway, with an $85 price target for the class B shares, and said on Feb. 27 that “(fourth quarter 2011) operating earnings were below our outlook, driven by lower-than-expected Insurance unit earnings,” but that “on a positive note, earnings growth in the non-insurance businesses was strong,” particularly for Burlington Northern Santa Fe, which Berkshire acquired in February 2010.
Gelb estimates that Berkshire Hathaway will earn $5.45 per class B share during 2012, followed by earnings of $5.80 a share in 2013.
4. Ace Limited
Shares of Ace Ltd. of Zurich closed at $71.49 Thursday, returning 3 percent year-to-date, following last year’s 15 percent total return.
The company is currently paying a quarterly dividend of 47 cents a share, but announced on Feb. 23 that its board of directors would propose an annual dividend of $1.96 a share — distributed in quarterly installments of 49 cents — at Ace’s annual meeting in May. On the rather safe assumption that shareholders will approve additional gravy, the forward dividend yield is 2.74 percent.
The shares trade for 0.9 times tangible book value and 9.5 times the consensus 2012 earbings estimate of $7.55 a share. The consensus 2013 earnings per share estimate is $7.59.
The company earned $1.6 billion, or $4.65 a share during 2011, declining from $3.1 billion, or $9.11 a share, in 2010, mainly because of $795 million in realized losses on investments. Excluding the investment losses and $432 million in gains recorded in 2010, Ace earned $1.94 a share in 2011, compared to $2.05 a share the previous year.
Ace issued guidance for 2012, with operating income “expected to range between $6.65 and $7.05 per share.”
Credit Suisse analyst Michael Zaremski has a “neutral” rating on Ace, with a $73 price target, and said last month that an update of crop insurance premium methodology by the U.S. Department of Agriculture’s Risk Management Agency would lead “lower insurance rates for corn and soybean producers (farmers) in the 2012 crop year.”
The analyst said the premium changes “current crop prices (and lower levels of crop volatility) point to top-line declines in the 4 percent to 8 percent range for the 2012 crop season” for Ace’s crop insurance business.
Zaremski lowered his 2012 earnings per share estimate for Ace by six cents to $7.16, while also saying “the economics of crop insurance remains relatively attractive and Ace has been a best in class crop underwriter over the years.” The analyst estimates Ace will earn $7.15 a share in 2013.
3. The Travelers Cos.
Shares of The Travelers Cos. closed at $57.10 Thursday, for a 3 percent year-to-date decline, following last year’s 9 percent total return. Based on a 41-cent quarterly payout, the shares have a dividend yield of 2.87 percent.
The shares trade for 1.3 times tangible book value, and for 10 times the consensus 2012 earnings per share estimate of $5.74. The consensus 2013 earnings per share estimate is $6.04.
Travelers earned $1.4 billion, or $3.36 a share during 2011, declining from $3.2 billion, or $6.62 a share, in 2010, because of a $4 billion increase in claims and claim adjustment expenses, and because the prior year included a $1 billion tax benefit.
KBW analyst Cliff Gallant has a “neutral” rating on Travelers, with a $60 price target, saying on Thursday that “the company’s overall reserve position is adequate with little net redundancy or deficiency,” and that because there is “less cushion in the reserves” than in previous years, he expects “that the likelihood of earnings ‘misses’ is greater, and there is less ability to offset some of the other (return-on-equity) pressures on the business such as low investment yields.”
Travelers repurchased 20.9 million shares for $1.2 billion during the fourth quarter, with total 2011 repurchases of $2.9 billion. During the company’s fourth-quarter earnings conference call on Jan, 24, CFO Jay Benet said that Travelers had been “diligently and systematically identifying opportunities to free up capital, returning that freed up capital to our shareholders,” and hinted that the buybacks would be curtailed, as “the process of freeing up capital is now largely complete.”
2. Prudential Financial
Shares of Prudential Financial closed at $61.88 Thursday, returning 23 percent year-to-date, after pulling back 12 percent during 2011. The company paid an annual dividend of $1.45 a share in November, increasing from $1.15 in November 2010. Based on the most recent annual dividend, the shares have a dividend yield of 2.34 percent.
The shares trade for just 0.8 times tangible book value, and for nine times the consensus 2012 EPS estimate of $7.00. The consensus 2013 EPS estimate is $8.19.
The company earned $3.5 billion, or $6.41 a share, during 2011, increasing from $2.7 billion, or $6.17 a share, during 2010. Total revenue increased 29 percent year-over-year, to $39.4 billion in 2011, while adjusted operating income increased 7 percent to $4.3 billion.
Evercore Partners analyst Mark Finkelstein on Feb. 23 raised his 2012 EPS estimate for Prudential by a dime to $7.07 and his 2013 estimate, also by 10 cents, to $8.27, to reflect “the impact of higher equity markets, with modest model refinements throughout.”
The analyst rates Prudential “equal-weight,” with a price target of $70, saying “PRU has solid growth prospects, both domestically and abroad, and a strong capital position. And although some businesses are showing pressure (e.g. group, full service retirement), we generally like the businesses PRU is in.”
Finkelstein added that with returns on equity ”expanding to close to 13 percent by 2013, with good growth and attractive businesses, we see the shares as attractive in what we believe is still an undervalued sector,” and “continue to see capital deployment a key theme and positive for PRU between buybacks and strategic M&A.”
Prudential repurchased 19.8 million shares of its common stock during 2011 for a total of $1.0 billion, for an average price of $50.53 per share.
Shares of MetLife closed at $38.09 Thursday, returning 22 percent year-to-date, following a 28 percent drop in 2011. The company paid an annual dividend of 74 cents in November, which was unchanged from a year earlier. The shares have a dividend yield of 1.94 percent.
The shares trade for 0.9 times tangible book value and 7.5 times the consensus 2012 earnings per share estimate of $5.09, making for the cheapest forward P/E among this group of five large-cap insurance companies. The consensus 2013 earnings estimate is $5.58 a share.
MetLife is in the midst of a transition from being considered a bank holding company, and consequent regulation by the Federal Reserve . The company agreed in November to sell “most of the depository business” of its MetLife Bank subsidiary to General Electric unit GE Capital. In January, MetLife announced it was exiting the forward residential mortgage business.
MetLife continues to originate reverse mortgages and to service existing mortgage loans.
The sale of the MetLife Bank depository business is expected to be completed during the second quarter, after which the company plans to deregister as a bank holding company.
The Federal Reserve in October rejected a capital plan submitted by MetLife that included plans to increase the company’s return of capital to investors, through dividend increases and share buybacks. The company is currently undergoing the annual round of Fed stress tests, with results expected to be publicly announced by the regulator on Friday.
The company reported 2011 net income to common shareholders of $6.7 billion, or $6.29 a share, increasing from $2.7 billion, or $3 a share in 2010, with increases in premiums, policy fees and investment income growing total revenue by 34 percent to $70.3 billion.
Bank of America Merrill Lynch analyst Edward Spehar rates MetLife a “buy,” with a price objective of $56, saying last Monday that “capital distribution will be a catalyst” for the shares this year, with a “substantial” dividend increase and share buybacks.
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