Description

Summary:

Twelve years ago Vinlin wrote a well-deserved VIC winner on WRB. The valuation was compelling and his analysis excellent: The stock has compounded (with dividends reinvested) at over 15%/year since.  I would strongly encourage anyone with an interest in the company to read the report and the responses to the subsequent comments and questions.  While much has changed in the ensuing years, Vinlin captures the spirit and culture of the company.  

Berkley was a great idea then; it is a very good idea today for those of you looking for stocks you can own for a very long time.  There are two keys to success in the property/casualty industry:  Establishing sufficient reserves and a willingness to relinquish business when pricing is unattractive. WRB, which will mark its 50th anniversary as a public company this year, has proven itself on both counts. Not coincidentally, Bill Berkley at 77 is still deeply engaged, owns 20% of the stock (his percentage ownership has actually risen over the last decade given corporate repurchases!), and has created a system where the top 70 or so executives receive large stock grants tied to corporate returns which must be kept until after they retire.  The owner-operator ethos and focus on risk adjusted returns is pervasive.

Pushback:

All well and good, but the stock has been great! And it’s over 2X book value. Everyone knows the story. And yes, we’re in a hard insurance market, but the rate of change is slowing and after hard comes soft--so isn’t it too late (or too early)?

Responses:

1.  The market is less homogeneous than in the past, so it is not as meaningful to generalize about “the P-C cycle.”  One very important market segment (Workers’ Comp) is extremely competitive with eroding pricing.  CEO Rob Berkley has been (wrongly) predicting an upturn in the market for over two years but, responding to the soft market, the company has lessened its exposure here.  Most recently on the Q4 call, he suggested that it would bump along the bottom in 2023 and could show considerable firming in 2024 and beyond.  An opportunity lies closer at hand in the property market, both reinsurance and insurance because of a hard reinsurance market. Though historically WRB does not have as much exposure to property as casualty lines, its decentralized structure and willingness  should allow it to capitalize upon this opportunity. Finally, Rob suggests that a healthy amount of business is still migrating from standard lines to the excess and surplus lines that have traditionally been WRB’s sweet spot.  For these reasons, I conclude that business conditions will remain stronger for longer than many expect, especially for a company that has demonstrated an ability to be opportunistic. 

2.  Investment income should surge higher. At 12/31 WRB had $24.5 billion in invested assets ($88/share).  The duration of the fixed income book is 2.4 years–kept deliberately short over the last several years.  Hence, repricing to new money rates, which are now over 5%, will happen in short order. As Bill Berkley noted in September at the KBW conference, “Many underestimate the earnings power of a business like the one we work for when it comes to where interest rates can take investment income.”  I do not have access to sell-side models but I suspect he is right.

3.  Since 2000 the stock has declined in only four years:  2007, 2008, 2009 and 2020.  Incredibly, there have been only two times in this same period (including intra-year moves) where it has had 20% or more peak-trough declines. My point is that one doesn’t need to wait to try to time the beginning of the next hard market to buy WRB.

4. Though not perfect in timing, the company has been astute in buying back stock over the years,  The most notable example was in the COVID market of 2020. WRB bought back $346MM of stock at an average price of $36–a meaningful amount and, in hindsight, a very well-timed purchase. Beginning in 2011, there have been 10 quarters in which repurchases exceeded $50MM.  In each case, the stock appreciated one year out and, looking 3 years out (of course with the first two quarters of 2020 we do not yet know exactly but it looks as if it will be the case), produced a total return of at least 40%.  So I think it is noteworthy that in the recent 4th quarter, the company bought back $87MM at an average price of $69.  We all have become cynical about share repurchases and can go into chapter and verse about egregiously mistimed buybacks, but always remember that Bill Berkley began his career as an investor and approaches the world with that lens.

Earnings Power/Valuation:

EPS should top $5 in 2023 and be in the $6 neighborhood in 2024. Looking out two years, most if not all of the unrealized investment losses in the bond portfolio should reverse.  Accordingly, tangible book value ($24.58 at 12/31/22) should rise to the high $30’s. Higher interest rates are leading management to be much more confident about reaching and exceeding their long-term goal of a 15% ROE.  On this basis, I think a 18-24 month target in the $80-85 range is very realistic. I hope and expect to own the stock for much longer.

Risks/Concerns:

This is a black box industry and reserve adequacy should always be the greatest concern of investors.  I take comfort from the large insider ownership, the track record (well laid out in the attached corporate presentation), the emphasis on small individual risks, and the meaningful decline in the paid loss ratio in recent years.  

Investor Presentation:

https://s29.q4cdn.com/304856890/files/doc_presentation/2022/02/17/Investor-Primer-2021YE.pdf

Catalyst

I wish I had one.