Description

Based in DeRidder, Lousiana (population: 9,800), Amerisafe is a workers comp insurance company focused on small and mid-sized employers engaged in hazardous industries such as commercial construction, trucking, agriculture, logging, oil and gas, maritime, and sawmills. Of note, AMSF generated approximately 40% of its 2009 premium volume from the commercial construction sector, which will likely cause severe headwinds in premium growth for the next couple of years. After peaking in 2006 (see chart below) gross premiums fell 1% in 2007, another 6% in 2008, 15% in the first nine months of 2009, and finally accelerated to -27% in the Q3/09 alone. I believe gross premiums will likely be down another 5-10% in 2010 (vs. the sell-side which is projecting flat or down 1-2%). While the company has launched some initiatives to offset the sharp declines (i.e. geographic expansion into Iowa and Alaska and industry expansion into auto mechanics), I think these will be minimal as the company’s inherent conservatism will prevent it from aggressively expanding into areas where it doesn’t have a lot of experience. The following link provides a very informative and easy-to-understand presentation on AMSF. It is worth spending a few minute perusing: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjU3NDA3OXxDaGlsZElEPTM2MTYzNnxUeXBlPTI=&t=1  

Additionally, as its $717M investment portfolio continues to reprice to the lower interest rate environment, investment/interest income should also continue to fall. Investment income was $6.9M in Q3/09, down 10% over the year. You can see the trend in the chart below. 

What the above table should also reveal is that AMSF is in a very cyclical industry. Underwriting profits have been stellar the last few years (84-92% combined ratio since 2006), but its experience in the early part of the decade with combined ratios at or above 100% for four years is indicative of the problems that can occur, especially in a declining revenue environment where operating leverage will be negative. 

Recent Results
AMSF blew away Q3/09 results with EPS of $0.67 vs. consensus estimate of $0.54. All of the beat was driven by reserve releases. For you non-specialists out there, that basically means the estimated loss content of insurance written in previous years has been less than expected. This is evident in the table above where you can see that the loss ratio from prior years was -12% in the quarter. Much of the insurance industry has been experiencing favorable prior year loss development, but this is unsustainable and considered low quality earnings. Tellingly, AMSF traded down on the day it released results despite the beat because the critical variable was the premium volume, which was down sharply. 

AMSF also recently repaid $25M in convertible preferred stock, which had some strict covenants attached, the most important of which were no dividends for the common stock and no stock buybacks. While some on the sell-side have seized on this as a positive catalyst, I believe insurance companies with sharp declines in revenue will not be well-served by repurchasing stock at a premium to book.  
 
 

Valuation
AMSF trades at 119% times Q3/09’s diluted book value of $15.32 and will probably be near $15.85 at year-end. With many profitable insurance companies currently trading at or below book value, 1.0 times book value represents an appropriate value for Amerisafe. With the stock at $18.20, there is 13% downside.  

Catalyst

Continued decline in premium volumes

Declining investment income

Worsening loss ratios and operating leverage