Description

1347 Property Insurance Holdings, Inc. (NasdaqCM: PIH)

Summary

1347 Property Insurance Holdings, Inc. is an exceptionally undervalued property and casualty insurance company that has been public for about one year.  PIH’s core business at this stage is insuring underserved homeowners in Louisiana, a market in which the management team has significant experience.  The street has overlooked the opportunity here due to the small market capitalization and the stock represents an opportunity to purchase an ownership stake in PIH at below tangible book.  PIH currently trades at 0.97x its tangible book value, which we believe is meaningfully undervalued compared to its peers, especially given PIH’s substantial growth runway.  Furthermore, the pace at which new policies are being underwritten suggests that there should be meaningful book value accretion in the near term.

In terms of will the stock work, we think so.  There have been a number of changes recently adding new board members to the PIH board.  We view this is probably a move directly as a result of pressure applied by Legion Partners which is a 10% holder of PIH.  Legion is an activist fund that has a long track record of driving shareholder returns.  We have heard rumors that they plan to be much more aggressive with PIH in 2015 and beyond if the stock does not begin to reflect fair value which is in the range of $15 to $21 per share.  The recent Legion Partners fight at Perry Ellis (PERY) provides a view into their potential to act as a value enhancing catalyst.

Company History

PIH was incorporated under Kingsway Financial (TSX:KFS) in October 2012 to underwrite homeowner policies in Louisiana.  The Louisiana homeowner insurance market is quite attractive, as many of the largest national carriers have been reducing exposure, creating an opportunity for niche providers with good local market experience.  Given the reduction in premiums written by the largest national carriers, homeowner insurance rates continue to remain attractive in the coastal markets.  Further, the cost of reinsurance—transferring a portion of the risk of a catastrophic events to reinsurance carriers—has been declining significantly over the last several years.  The net result of these factors leads to an extremely attractive opportunity to underwrite Louisiana homeowner policies.  PIH was established to capitalize on this opportunity.

PIH underwrites on both a voluntary basis through a network of more than 130 independent agents and purchases policies directly from an insurance company created by the state of Louisiana called Louisiana Citizens Property Company (“Citizens”).  Every year, state-approved insurers have the opportunity to assume policies written by Citizens.  As of December 31, 2014, PIH had 22,300 policies; 65% of total policies in-force on a voluntary basis, and 35% of total policies in-force from Citizens.  PIH's policies from Citizens insure primarily wind and hail exposure.  The policy growth at PIH has been phenomenal – 60% growth was recorded in policy count in 2014.

PIH purchases reinsurance coverage to lower its risk of catastrophic storm events.  PIH buys coverage for up to a 1-in-100 year size storm, which costs roughly $0.40 of every $1.00 gross written premium.  As noted above, the cost of such reinsurance has been rapidly declining and reinsurance renewals for the reinsurance year beginning June 1, 2014 were 10% to 20% below the prior year on a like policy basis.  For the upcoming reinsurance 2015 reinsurance year we expect costs to decline an additional 10% to 15%.  The reinsurance coverage is comprised of an array of policies from different carriers, each taking a portion of the risk.  The maximum loss that PIH can sustain in the current storm season beginning June 1, 2014 is $5 million (less than 10% of PIH’s current capital base) for any number of storms as long as no event exceeds all of the coverage and that no single storm generates a loss above $92 million.

PIH plans to diversify its business outside of Louisiana, employing part of the excess capital on its balance sheet to achieve this goal.  Management has noted a focus on three other states: Florida, Texas and Hawaii.  Texas will be the next market PIH will enter and was granted approval May 12, 2015.  The market didn’t seem to care about this announcement further reinforcing our view that no one is really watching.  Beyond Texas, management is actively evaluating other states to enter and we expect more positive announcements to follow.

Another huge positive for the stock has been the recent termination of the Management Services Agreement with a Kingsway affiliate.  This agreement was a huge long-term negative in our view.  It was a perpetual payment of 1% of premiums for “strategic” advice, etc.  Given the huge growth we expect at PIH getting rid of this ridiculous arrangement was near-term pain for long-term gain – the cost of the termination is all factored into the current book value.

Management Team

PIH’s experienced leadership team is a key strength.  The management team has significant working knowledge of coastal markets, and has worked together in the past.  Doug Raucy, PIH CEO, age 58, seems to view PIH as the pinnacle of his career, bringing together years of industry knowledge and experience forming businesses.  While certainly focused on building a larger business, he seems sensible about taking well-priced, opportunistic risk rather than growing for the sake of growth.  John Hill, CFO, is a highly experienced insurance industry veteran who worked with Doug at Prepared Insurance.

Valuation:

We believe that the current coastal insurance market is so attractive that an insurer like PIH can likely earn close to 50% return on equity assuming a 3 to 1 ratio of gross premium written to capital.  On a more steady-state long-term basis, it seems reasonable that by employing disciplined underwriting practices in niche markets that have been neglected by the majors, PIH should earn a low- to mid-teens return on equity. That being said, we would note that we purposely remain conservative in our modeling assumptions going forward.

We have valued PIH using two primary methodologies: discounted cash flow and comparable peer multiple analyses producing estimates of $21 per share (177% above current price) and $15 per share (98% above current price), respectively.

A table showing PIH and its directly comparable peers is below (as of 5/28/15):

Source: Capital IQ

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Catalyst

Wall street discovers this gem, earnings go up, Legion Partners becomes aggressive