Description

Alleghany is a holding company that is primarily focused on reinsurance and insurance underwriting businesses, with a growing collection of owned middle market / private equity-type companies that are likely to provide a diversified source of earnings and cash flow back to the parent over time. 

Alleghany was written up on VIC back in September 2017 by natty813 at a price of $543, which was a multiple to 99% of book value at the time.  I recommend reading that write-up for an interesting and well-written overview of the business and the company’s unique history. Natty’s thesis was that concern about insurance losses related to the Hurricanes Harvey and Irma in August of 2017 had depressed the stock in the near term, but that improving insurance pricing and continued strong capital allocation would eventually drive the stock closer to his estimated fair value of 1.3X BV.  This thesis played out almost exactly.  By May of 2019 (when Natty closed out his position on VIC) the stock traded at ~$670 after reporting Q1 2019 BVPS of $570 (1.18X book value) and having paid a special dividend of $10 per share in early 2018.  The stock went on later to trade at a high of over $820 per share as of mid-February 2020 after Alleghany’s book value grew by 15.8% in 2019 to end the year with BVPS of $611 per share, implying a P/BV ratio of 1.34X at the highs.  

Today the stock trades at around $600, with the most recent BVPS (Q3 2020) of $606.21, and I think the setup is similar to that described in the September 2017 write-up.  I expect the company to take advantage of the much-improved insurance pricing that has already begun and which may set the stage for a multi-year period of attractive underwriting profits for Alleghany’s insurance and reinsurance businesses.  At the same time, I expect that Alleghany’s growing private equity operations will start to be increasingly noticed by the market as these businesses gain scale.  Finally, I expect that Alleghany will opportunistically make good capital allocation decisions to grow book value per share.

This write-up will take something of a narrative form as more of a detailed update of the September 2017 idea submission – so again, if you are interested please go back and read that for background.

Quick Overview of the Business

Here is a quick overview of the business before I move forward with the update for those who are not inclined to read the prior write-up.  Alleghany is a “total return” insurance holding company that operates very similarly to Berkshire, Fairfax, or Markel, where insurance units operate quasi-autonomously and excess capital is sent by the subsidiaries back to the parent holding company for allocation.  In the case of Alleghany, the recent emphasis has been on investing in middle-market private companies to generate growth and cash flow over time that adds a third leg to the classic two insurance value creation levers of underwriting profits and intelligent public market stock and bond investing.

Alleghany ended 2019 with shareholders’ equity of just shy of $8.8B.  TransRe is a global reinsurance business that accounted for $5.2B in book value.  Alleghany bought TransRe back in 2012 in a timely deal, and I view TransRe as a somewhat above-average reinsurance business. RSUI is a specialty wholesale commercial insurance underwriting business with roughly half the business devoted to property insurance and half to non-property lines such as professional liability.  RSUI has been a top-tier performer in its industry niche for over three decades.  Despite only comprising about $1.8B in shareholder equity, RSUI punches well above its weight in terms of value generation for Alleghany.  CapSpecialty is another specialty insurance company focused on commercial surety and professional liability aimed at small and mid-sized businesses.  CapSpecialty comprises less than $400M in book value and has been a break-even underwriter for the last several years.  Allied Capital Corporation represents Alleghany’s private equity operation and accounted for $900M in shareholder equity at year-end 2019.  There are currently seven different “platform” companies that produced over $2.2B in revenue in 2019.  Lastly, there are a few odds and ends from Alleghany’s various investment activities in the past that comprise about $360M in book value.

2017-2019 Summary Review

To pick up from the story back in late 2017, Alleghany managed to grow book value by 7.4% in 2017 despite significant cat losses from the hurricanes, thanks mainly to strong investment returns in the insurance portfolio.  In early 2018, Alleghany paid a $10 per share special dividend. 

2018 turned out to be a more difficult year for Alleghany than 2017 was, at least in terms of growing book value per share.  For the full year 2018, Alleghany reported net income of $242.9M or $16.13 per share, but BVPS declined by 4.6% as compared to year end 2017 due to fair market value changes in the investment portfolio of $382M due to the nasty stock and bond market sell-off that occurred in the last month or two of 2018.

Both the stock market and Alleghany bounced back and reported a strong year in 2019, with reported revenue up 17% to $8.4B, and net income of $344.6M, or $23.82 per share.  Importantly, pricing across many of Alleghany’s insurance lines began to strengthen noticeably in 2018 and 2019, and Alleghany responded by writing more business. Alleghany’s consolidated gross written premium (GWP) rose 12.9% in 2019, with all three of its major insurance/re-insurance businesses posting double digit percentage growth.  BVPS increased from $527.75 per share at the end of 2018 to $611 per share at year end 2019, up 15.8%.  Alleghany paid another special dividend of $15 per share in March 2020.  This represented a ~1.9% dividend yield at the prevailing stock price and at the time represented about 2.45% of Q4 2019 reported book value.

2019 Detailed Review

I’ll start the 2019 review with Alleghany’s reinsurance business TransRe, which reported a small underwriting loss in 2019 despite lower-than-average industry catastrophe losses due to the company’s exposure in Japan, where two cyclones caused almost 30% of the global cat losses in the year. TransRe ended 2019 with its third straight year of underwriting losses ($41M) though the company was still profitable due to investment income. 

Under Alleghany’s ownership from 2012 through the end of 2019, TransRe had produced just over $1B in underwriting profits with a combined ratio of about 96.4%.  However, the three years from 2017 to 2019 were all elevated cat loss years for TransRe.  In each of 2017 and 2018 TransRe reported cat losses exceeding $500M, followed by $301M in cat losses in 2019.  By comparison, in the prior five years (2012 to 2016) TransRe suffered a total of $588M in cumulative catastrophe losses. 

Despite soft recent year results, through the end of 2019 Alleghany’s investment in TransRe has been a good one (though obviously not as good as it looked three years ago).  Alleghany paid $3.5B for TransRe in early 2012 and has received $1.6B in dividends that reduce its net cost to $1.9B.  TransRe ended 2019 with $5.2B in book value and would likely sell for a modest premium to book value in any kind of M&A transaction.  I expect that TransRe is due for a reversion to its historical levels of underwriting profitability.

RSUI, which is Alleghany’s wholesale specialty commercial insurance company, enjoyed a strong year of growth in 2019 and reported a nicely profitable year despite also experiencing above-average cat losses    RSUI reported underwriting profits of $101M on net earned premiums of $824M in 2019.  RSUI appears have built a corporate culture that emphasizes underwriting profitability first and foremost, with an incentive structure that empowers its underwriters to shrink or grow business based on market conditions.  A lot of insurance businesses say they do this, but very few truly can.  RSUI appears to be one of the few. In his annual letters, Weston Hicks has asserted many times that RSUI’s long-term underwriting record “stands among the best in the business.”  Over the eight years from 2012 to 2019, RSUI Group produced $721 million of underwriting profits for Alleghany.

In the 2019 annual letter, Hicks wrote: “From 2014 through 2018, RSUI shrank, as new business opportunities were insufficient to offset decreases in the company’s renewal premiums. This began to change in 2019, with quarterly growth accelerating as the year unfolded. For the full-year, RSUI produced a 20% increase in gross premiums written, with the fourth quarter growth rate at a sizzling 31%.”  Since Alleghany acquired RSUI on July 1, 2003 for less than $700M, cumulative underwriting profits have totaled $1.77 billion with an average combined ratio of 88.2%.  RSUI’s shareholder equity at year-end 2019 was $1.874B after having distributed over $1B in dividends to Alleghany over that period. There is no doubt that RSUI is the premier asset within Alleghany’s insurance operations, and I would imagine that this business would bring a multiple of something like 1.5X book value if it were to be sold to a strategic acquirer. 

CapSpecialty is Alleghany’s specialty insurance business with a focus on commercial surety and professional liability.  After producing small underwriting profits in 2016, 2017, and 2018 (between $4M and $7M each year) CS posted an underwriting loss of $27M in 2019 on net written premiums of $345M.  In mid-2019, Alleghany’s former CFO Jack Sennott was appointed CEO of CapSpecialty. 

Sennott reviewed and strengthened the company’s reserves in late 2019 to reflect rising recent year loss experiences in professional liability lines, which is what caused the large underwriting loss for the year.  Sennott also is working to reduce the company’s expense ratio and closed two regional offices in 2019. 

I think CapSpecialty might need more scale to reach consistent profitability and it remains a work in progress.  Given that CapSpecialty comprises less than 5% of Alleghany’s book value it doesn’t really impact the valuation of the parent much either way in its current state. But it would be a positive development if Alleghany were able to build this into a consistently above-average specialty insurance business, which is the goal for now.

In Natty813’s write-up, he included a description of Alleghany’s California workers comp insurance group (called PacificComp).  Alleghany sold this business in December 2017 for approximately $158M and recorded a small gain on the sale.   I was happy to see Alleghany exit this business, as workers comp is a difficult business and I’d rather see the company allocate its time and capital elsewhere.

This brings me to Alleghany Capital Corporation, which is now turning into a very respectable private equity portfolio where Alleghany owns controlling stakes of established, profitable middle-market, non-financial businesses.  ACC’s portfolio companies enjoyed a strong year in 2019, with revenue up 45% to $2.297B, and pre-tax earnings grew 86% to $111 million, thanks to a combination of organic growth and several add-on acquisitions to ACC’s platform companies. 

Here is CEO Weston Hick’s description of Alleghany’s strategy with ACC from the 2019 shareholder letter:

“Alleghany Capital focuses on investing in companies run by entrepreneurial founders or managers who share our long-term approach to business, are committed to capturing developing opportunities in their industries, and have a clear strategy and nimble operating mindset that will drive future growth through various market cycles. We look for companies that have an opportunity to accelerate growth within their markets by leveraging our ability to support accretive follow-on investments in both organic and acquisition growth initiatives.  Our current portfolio is comprised of companies that hold #1 market positions in niche markets or are rapidly gaining share in large fragmented markets.”

At the end of 2019, Alleghany Capital had seven platform businesses.  

W&W/AFCO Steel is the largest and most diversified company in the fabricated steel production for use in steel bridges, public projects, and overpasses in North America, and also is involved in delivering steel structures in major construction projects in some markets (which in 2019 included the Texas Rangers stadium and the Las Vegas Convention Center).  W&W/AFCO made a snap-on acquisition of Hirschfield Industries in 2018.  According to the annual letter, W&W/AFCO grew revenue by 18% and earnings “at a much greater rate” in 2019 and entered 2020 with a large backlog and substantial project pipeline.  Alleghany owned 80% of W&W/AFCO at year-end 2019.  ACC’s carrying value for W&W/AFCO was $255M at year-end 2019.  Reported revenue for 2019 was $825.7M.

Kentucky Trailer manufactures custom trailers and truck bodies for uses such as moving/storage, mobile medical, express package delivery, and other specialty markets.  Kentucky Trailer has made two tuck-in acquisitions, buying CEI Equipment in late 2018 and Warren Manufacturing in July 2019, which made Kentucky Trailers into the leader provider of animal feed transportation trailers.  At year-end 2019, Alleghany owned 77% of Kentucky Trailer. ACC’s carrying value for Kentucky Trailer was $81M at year-end 2019.  Reported revenue for 2019 was $240.6M.

Wilbert Funeral Services is a provider of products and services for the funeral and cemetery industries and makes pre-cast concrete products serving the funeral market.  Wilbert grew revenue in 2019 and acquired Astral Industries, which makes caskets.  Prior to 2020, Alleghany’s ownership of Wilbert Funeral was 45%, but this increased to 100% in mid-2020.  It also bears noting that prior to 2020 Wilbert was accounted for under the equity method of accounting, whereas going forward from2020 it will be a fully consolidated holding for GAAP accounting purposes. This will make it much more visible on Alleghany’s financial statements. ACC’s carrying value for Wilbert was $81.6M for its 45% ownership at year-end 2019 and as of Q3 2020 that was bumped to $142.6M.  Wilbert is about a $150M annual revenue business.

Alleghany formed Precision Cutting Technologies as a holding company in mid-2019 to hold the company’s portfolio companies that serve the machine tool and consuming cutting tool markets. At the end of 2019, PCT was comprised of three companies: Bourn & Koch is a maker of precision machine tools and replacement parts, Diamond Technology Innovations makes consumable diamond nozzles for waterjets, and CID Performance Tooling (acquired in June 2019) makes precision tools for the aerospace market.  PCT entered 2020 with a significantly larger backlog than in 2019, and Alleghany expects to be active in looking at potential add-on acquisitions to build up this vertical.  ACC owned 100% of Precision Cutting at year-end 2019. ACC’s carrying value for PCT was $105M at year-end 2019, and 2019 full year revenue was $39.3M.

Jazwares makes toys, musical instruments, and other entertainment products and offers a wide portfolio of licensed and owned products.  Jazzwares grew revenue by 44% in 2019 and produced “record earnings” thanks to new product licenses including Fortnite, Peppa Pig, and Roblox, despite being impacted by tariff issues.  Jazzwares acquired Wicked Cool Toys in October 2019, which brings several licenses including Pokemon, Cabbage Patch Kids, and Halo.  ACC owns approximately 75% of Jazzwares. ACC’s carrying value for Jazzwares was $235M at year-end 2019.  2019 reported revenue was $351.2M.

Integrated Project Services (IPS) provides various design, engineering, and other strategic consulting services to the pharmaceutical industry, specifically for the purpose of designing their R&D, manufacturing, packaging, and warehouse facilities.  In May 2019 IPS acquired a majority interest in The Cardinal Group, a construction management company serving the pharmaceuticals industry.  This is a growth area, and IPS boosted revenue in 2019 by 71% through a combination of strong organic growth and the acquisition.  Alleghany owned 85% of IPS at year-end 2019. ACC’s carrying value for IPS was $67M at year-end 2019.  2019 revenue was $646M.

The final non-industrial business is Concord Hotel Enterprises, which ACC acquired in October 2018.  In hindsight, the timing for ACC’s purchase was unlucky given what has happened to the hospitality industry since.  Still, Concord did have a good year in 2019, and ended the year operating 120 hotels and growing its rooms under management by ~25% to about 18,500 rooms for such brands as Marriott, Hilton, Hyatt, Choice, and IHG.  At year end 2019, Alleghany owned 85% of Concord.  ACC’s carrying value for Concord was $108.5M at year-end 2019.  Concord’s revenue in 2019 was $186M. Post-COVID, I do expect this business to do reasonably well, as hotel management is an attractive, capital light business model when well executed.

So that’s the private equity portfolio as it stood at year-end 2019.  As is the case with most private-equity type vehicles, ACC’s portfolio companies all carry some debt. At year-end 2019, the total debt was $367.1M, and was broken down as follows: $177.7M at Jazzwares, $59.5M at Kentucky Trailer, $57.3M at W&W/AFCO, $40.2M at IPS, and $32.4M at PCT.   Alleghany also made an intercompany loan of $33.2M to Concord in December 2019.  Importantly, other than the inter-company loan none of these liabilities are guaranteed by ACC or Alleghany. 

2020 Update Through Q3

The pandemic year has proven challenging for Alleghany’s insurance operations as well as some of the private companies in the Alleghany Capital portfolio.  Nonetheless, Alleghany’s BVPS of $606.32 as of September 30, 2020 was a slight 1.7% increase from the year-end 2019 figure when adjusted for the $15 per share special dividend paid out in March 2020.

Net premiums across Alleghany’s insurance and reinsurance businesses were 9.5% higher in the first nine months of 2020 versus 2019.  However, Alleghany posted underwriting losses of $145M for the period (103.2% combined ratio) which included $616M in catastrophe losses. Cat losses for the nine months included $160M from two hurricanes in Q3, as well as $400M in losses related specifically to the COVID-19 pandemic.  TransRe’s combined ratio for the first nine months was 103.9%, with pandemic-related insurance losses of $316M for the nine-month period. 

RSUI posted a slight underwriting loss in the nine-month period and a combined ratio of 100.9%, which included cat losses of $191M of which $110M were related to the two hurricanes in Q3 2020.  RSUI’s net written premiums jumped by 23% in the first nine months of 2020 as the pricing environment for several business lines improved significantly over prior years.

CapSpecialty grew its net premiums by 7.7% in the first nine months of 2020, with a combined ratio of 102.3% for the period which resulted in a modest underwriting loss.

Across its insurance and parent company investment portfolios, Alleghany generated $360M in investment income in the first nine months of 2020, which was lower than 2019’s investment income due to lower interest rates for most debt securities versus the prior year.

Alleghany Capital’s private businesses generated $1.654B in revenue in the first nine months of 2020, a decline of 4.2% compared to 2019.  Pre-tax earnings also were down ($80M in 9M2020 versus $102M in 9M 2019).  However, pre-tax earnings did show a strong jump in the most recent reported Q3 from the prior-year quarter ($70M in 2020 versus $38M in 2019) due in part to the inclusion of Wilbert in consolidated results.  But ACC also noted strong seasonal earnings at Jazwares as well as other subsidiaries starting to bounce back from pandemic-related restrictions.  

ACC completed three transactions in 2020, which included the planned purchase of the remaining 55% ownership of Wilbert.  Back in March 2020, Precision Cutting Technologies acquired a small company called Supermill that makes carbide end mills, and in April 2020 Jazzwares acquired a company called Kelly Toys, which makes plush toys including a line called Squishmallows, which have apparently sold over 50 million units. Also impacting Alleghany Capital’s reported sales and pre-tax profits were lower revenues at Concord’s hotel management business, as well as $11M of non-cash accounting charges to related to the step-up in inventory values at Wilbert and Supermill pursuant to acquisition accounting.

As of Q3 2020, Alleghany Capital’s portfolio companies were carried at $1.097B.  In looking at the disclosed financial results from each of the seven businesses for the first nine months of 2020, here were the revenues and % change from the prior year period listed in order of revenue:

W&W/AFCO - $547.6M in revenue, down 16.9%

IPS - $439.6M in revenue, down 7.8%

Jazwares - $273M in revenue, up 10.3%

Kentucky Trailer - $152.6M in revenue, down 28.3%

Wilbert - $116M in revenue, figure not available for prior year

Concord - $94.3M in revenue, down 31.2%

PCT - $31.1M in revenue, up 24.4%.

Alleghany has two other assets in its corporate portfolio worth mentioning, one of which (Stranded Oil Resource Corporation) was divested in Q4 2020.  This was a business devoted to enhanced oil recovery methods, and Alleghany had been supporting this business for many years and will probably book a cumulative loss of $200M+ in this asset over its holding period.  Alleghany had written down the investment from $87M at year-end 2019 to $24M as of Q3 2020, so at the very least this will no longer be a source of value leakage for Alleghany going forward.  The other asset is Alleghany Properties, held at a value of about $24M, which comprises about 125 acres of property in the Natomas Crossing area north of Sacramento, CA.  The last update I have seen for this asset was a note in the 2018 annual letter when Alleghany sold 104 acres for $46.8M to a major healthcare company to use as a regional headquarters building.  This sale was expected to increase development interest in the remaining acreage, and Alleghany had expected to sell the remaining parcels over “the next couple of years.”  I expect that COVID extends the time frame for any such sales, but it is obviously not particularly material to Alleghany at its current size.  

Management and Capital Allocation

Alleghany’s corporate culture is one of prudent, value-oriented capital allocation with a strong risk-adjusted element.  “Conservatism dominates our philosophy” is the slogan that you will see in big letters when you click on the Alleghany corporate website main page.  The primary goal is to compound at 7-10% per year without taking excessive risk.  Current CEO Weston Hicks has now been with the company for 20 years.  Hicks inherited a company that had just sold off most of its assets and was basically sitting in cash and a huge stake in Burlington Northern, and his major capital allocation decisions since have been quite good.  The purchase of RSUI in 2003 was a masterful investment, and the acquisition of TransRe in 2012 was done at a time when reinsurance businesses were out of favor, and Alleghany got a good asset at a great price.  Not everything has gone perfectly, of course, but by and large I believe Hicks is an above average capital allocator – if you like your capital allocators to be focused on risk as much as reward.

Hick’s right-hand man with regards to insurance and investments is Joe Brandon, which many of you will remember as being formerly a well-regarded insurance executive with Berkshire Hathaway’s General Re who resigned in the wake of a reinsurance investigation led by former NY AG Elliott Spitzer (and was later cleared of any wrongdoing).  For what it’s worth, my impression is that Brandon was and is both a stand-up guy and a talented insurance executive and that he took one for the team at Berkshire. 

Alleghany does not hold quarterly conference calls, but Weston Hicks writes long and thoughtful annual letters to shareholders, which are definitely worth your time if you have interest in the insurance industry.  Here is a link:

https://www.alleghany.com/investor-relations/annual-letters/default.aspx

Alleghany’s primary capital allocation strategy is to look first to deploy capital into its middle market private business ownership positions, where prices are reasonable.  The company would also likely be open to doing M&A in the insurance business if the price and asset were right.  In recent years, the company has been declaring and paying special year-end dividends to send excess capital back to shareholders ($10 per share in March 2018, $15 per share in March 2020).  Alleghany has also been buying back shares for many years.  Y bought back $114M worth of stock in the first nine months of 2020 at an average price per share of $589.  This reduced the shares outstanding to 14,180,619 shares as of September 30, 2019, for a reduction of 1.3% in shares out.  

Outlook

As mentioned earlier, as of February 2020 just prior to the COVID-related sell-off, Alleghany’s stock traded at over $800 on 2019 year-end book value of $611 per share.  In his 2019 year-end shareholder letter published in early 2020, CEO Weston Hicks discussed the re-rating of Alleghany’s stock from what had been around 1X book value two years prior to 1.3X at year-end 2019.  Hicks cited firming pricing in the re/insurance businesses after nearly a decade of flat to declining prices, both RSUI and TransRe having the capital to exploit an improved pricing environment, the strong performance of Alleghany’s investment portfolio, and Alleghany Capital’s increasing scale and importance as reasons why the stock market might be assigning a higher multiple to reflect the company’s improved outlook for value creation going forward.  Then, of course, the pandemic happened, and the stocks of financial companies got hit pretty hard and have been much slower than the broad market to recover.

My own view is that Alleghany is a reasonably safe buy at anything around stated book value and below.  I personally would only assign a 1.35X book value multiple if I were convinced that the insurance and reinsurance market was about to benefit from a multi-year period of declining capacity and higher premiums – OR if Alleghany did a really amazing acquisition that dramatically improved the future outlook for profitable growth.  But I do think that the stock is worth ~1.2X book value, and I also think the idea looks timely given the negative market sentiment and what looks like strengthening tailwinds in insurance and reinsurance pricing. 

I expect that going forward Alleghany should continue to be able to grow BVPS at roughly 7-10% per year.  In his 2018 annual letter, Hicks described in detail how GAAP accounting treatment for the ACC private company portfolio under-states the economic value being created there, and that as this part of the business scales the market will be able to see this value more clearly.  I do think that over time that the value of Alleghany Capital’s businesses will become more visible to the market as the operation scales and profits grow.  My gut tells me that recent pricing improvements (especially in Alleghany’s historically most profitable business, RSUI) offers a chance to hit the high end of that 7-10% BVPS growth range over the next couple of years if the pricing trend holds for a while.  The divestiture of Stranded Oil Resource at the end of 2020 will also eliminate a consistent source of prior year losses and make things look a little better going forward.   

I expect Alleghany to report year-end BVPS of between $615-625 per share.  If one assumes that the 1.3X BV share price is early 2020 was an anomaly and the “right” multiple to BV is more like 1.2X, the stock would be worth about $725-750 per share.  This feels directionally right to me.  

Catalyst

• Strong pricing in the insurance / reinsurance market enables Alleghany’s insurance operations to return to underwriting profitability after several underperforming years

• Growing scale of Alleghany’s private equity holdings begins to be recognized by the market.  

• Alleghany continues to grow BVPS at the high end of its historical 7-10% annual range.

• Special dividends and share buybacks are used with good effect to return capital to shareholders.