Description

Executive Summary

Crawford and Co is an undervalued insurance services company.  The shares are poised to unlock value and rise 50% over the next two years as the market properly prices the shares in line with the industry, pressure eases on their businesses from a variety of factors such as sustained higher GDP and lower unemployment, and cash flow is unlocked as the under funded pension liability is paid down.

Business Overview

Crawford and Co is an Atlanta based insurance services company with four divisions: (1) US claims management, (2) International claims management, (3) workers comp claims management division, and (4) legal settlement administration.

• (1) US Claims Management (20-22% of revenue)

Crawford provides insurance services to the P&C industry across the U.S.  Domestic P&C carriers for the most part have their own adjusters and use Crawford to work on overflow claims after some sort of event such as a severe weather, terrorism, or any other event that causes a spike in insurance claims.  There is a wide range of claims that are processed by Crawford from simple personal auto claims to more complex commercial claims, and as such, the range of revenue is very wide from as low as $150 all the way to $1,000,000 for very complex commercial claims.  Crawford has a range of personnel to work on the full spectrum of claims from field adjustors for the lower end claims to technical catastrophe adjustors for the higher end claims.

The two primary competitors for this business are York and Cunningham; I believe both are owned by private equity firms.  What drives business is geographical reach, technical expertise, quality of claim management which is defined by the carries using factors such as timeliness, accuracy of reports filed during the claim, and other reporting thresholds.

• (2) International Claims Management (38-42% of revenue)

Crawford provides essentially the same services internationally as they do domestically.  Their main markets are the UK and Canada which make up about two thirds of the division; the third largest international market is Australia.  Because of this international exposure, Crawford benefits from a decline in the USD when results are translated to the USD.  The main difference between the US and the International businesses is that international carriers tend to outsource about 50% of their claims management to third parties such as Crawford while domestic carriers only outsource about 20% of their claims management.  This makes the international business less volatile and less dependent on severe weather than the U.S. business.

• (3) Workers Compensation (23-33% of revenue)

Crawford, under the brand name Broadspire, manages workers compensation claims for self-insured companies.  For example, a supermarket will use Broadspire to manage a claim for a worker who slipped and fell while at work.  Broadspire will manage the entire cycle of the claim from ensuring that the worker gets proper health care, coordinating timeliness of claims, and preventing fraud.  This business is highly competitive with competition from Sedgwick CMS, Gallagher Basset, and ACE.  The client's buying decision is made in the clients risk management office. 

• (4) Legal (9-15% of revenue)

The fourth division is the legal settlements division which operates under the band name Garden City Group.  Garden City Group provides a wide range of services from processing class action lawsuits, administering bankruptcy cases, and special situation claims management such as the Gulf Oil Spill.  Given the broad range of cases from massive claims such as the IPO litigation settlement and the Gulf Oil Spill to very small bankruptcies, there is a wide range of revenue per case, a variety of factors that drive business to the Garden City Group, and revenue trends that can be difficult to predict from quarter to quarter.

Business Outlook by Division

The US claims business has been under pressure since the economy turned in 2008.  This business is driven by a variety of factors including overall economic activity and weather.  The higher the overall economic activity in a region, the higher the number of property and casualty claims.  For example, during economic expansion there are more miles driven which leads to more auto insurance claims.  Also, severe weather drives higher claims; this is not limited to national headline grabbing events such as hurricanes, but also includes localized snow or severe thunderstorms.  It is my opinion that the U.S. business has bottomed and will be at least flat in 2011.  2010 revenue was $190mm, and I am conservatively modeling 2011 revenue as $190mm despite the tailwind of economic growth we are seeing in the U.S.

The international claims business experienced some pressure in 2009, but rebounded in 2010.  The strength in 2010 was driven by the addition of new customers which offset lower volumes.  Additionally the economies of Canada and Australia have not experienced the level of declines seen in the U.S.  I am conservatively modeling 2011 revenue flat with 2010 levels.

The Broadspire workers comp business has seen severe volume declines as unemployment rose.  Now that unemployment has peaked, so has the pressure on this business.  As such, I am modeling this business to be flat with 2010 levels which was down 15% from 2009.  Broadspire is currently losing money on an operating earnings basis.

The Legal Settlement business saw massive growth in 2010 as they worked on the Gulf Oil Spill.  When this mandate goes away, the business will return to more normalized levels.  I am modeling that this business goes away after 1Q11 and am modeling revenue for the remaining three quarters as flat with 2009 levels.  Optically this does not look great, but it very easy to explain.  The following model removes non-cash goodwill impairment charges in 2009 and 2010 which amounted to $2.69 and $0.20.

Balance Sheet

Crawford has ~$220mm in long-term debt and $94mm in cash for a net debt position of $127mm.  Additionally, there is an under funded frozen pension plan which consists of a US plan and a UK plan.  The U.S. plan is about 70% of the overall liability and is frozen, and the UK plan is 30% of the liability and is closed.  Crawford made a $30mm payment in December and an additional $20mm in payment in January.  The plan, like most plans, is highly interest rate sensitive.  As Crawford continues to make payments to the plan, the under funded status will decline, payments will decline, and cash flow will increase.  They are making these payments with a term-loan due 2013.  Crawford intends to have the U.S. fund fully funded in 5 years and the UK fund fully funded in 13 years.  However, it is important to note that the payments will decline dramatically in two to three years, and also the interest rate sensitivity will cause the under funded status to decline dramatically if/when rates rise.

Cash Flow

Crawford generated about $26mm in cash flow from operations and had ~$13mm of capital expenditure for net free cash flow of $13mm.  I believe that the long-term FCF generation power of Crawford is conservatively $30mm which implies a FCF yield of 18%.  FCF in 2009 was $41mm and in 2008 was $55mm.  This equates to an average FCF over the last three years of $36mm.

Other Considerations

• Share classes - There are two share classes, A & B.  The A class shares are non-voting but have to receive a dividend at least equal to the B class shares.
• Family control - Jessie Crawford controls 52% of the class B shares and 43% of the class A shares.  If he decides to sell or trim his position, this would pressure the shares.
• Dividend - The company is currently paying a quarterly dividend of $0.02 per share which equates to a 2.6% yield.

Industry Trends

The most important factor to track for Crawford is trends in the P&C industry.  Organic growth in the industry is about 3%.  This is unsurprisingly about inline with GDP estimates.  As a point of reference, I'd point you to look at recent results from MMC who saw U.S. and Canada organic growth of 3% in 4Q10.  Aon also saw organic growth of 3% in the US.  This evidence bodes well for the claims management business which is about 55-65% of revenue.  For the Broadspire workers compensation business, I'd point to declining unemployment which will be a tailwind for this business over the next several years if the economy keeps adding jobs.

Valuation

Crawford currently trades at 6.2x the mid-point of 2011 EPS guidance of $0.46 to $0.52.  The best comp is Arthur J Gallagher (AJG) which trades at a forward P/E of 18.7x.  Unfortunately, there aren't a lot of other great comps but here is an attempt at a comp table:

Historically, Crawford has traded at 10x forward earnings with a range of 3.4x to 23.7x.  In 2008 the average was 15.8x, in 2009 the average was 8.2x, and in 2010 the average was 4.8x. 

I value Crawford at 10x 2011 EPS and arrive at a price target of $5.00 off of my EPS estimate of 50c.  This is in-line with historical averages and at a discount to its peer group.  I view my EPS estimate as very conservative; I can make the case that the U.S. business and the international business will be up in 2011.  Management issued 2011 guidance of $0.46 - $0.52, and the lone 2011 sell side estimate is $0.52.  In 2009, Crawford issued guidance of $0.41 - $0.47 and reported a two penny beat of the high end of that range with $0.49, and in 2010 they issued guidance of $0.44 - $0.50 and reported a blow out year of $0.73.  Also supporting the shares is a long-term FCF yield of 18%.  I would argue that a FCF yield of closer to 12% is fair which implies a share price of $4.75.  Anyway you look at it, Crawford is worth at least 50% higher than where it is currently trading.

I think it is probably important to note why the shares are trading at such an inexpensive valuation.  The reasons that I point to are the weak insurance claims volumes from a struggling economy which has pressured the U.S. and International claims business and also the end of the Gulf Oil Spill mandate.  I counter these points with the fact that the pressure on insurance claims volumes is abating as the economy improves, and with regards to the loss of the Gulf Oil Spill business, the expected decline in revenue is totally explainable and points to the strength of the franchise.  The other factor is the debt and pension fund liabilities.  I am not worried about this as Crawford can afford to make the payments, and the pension contributions will ease two years from now.

Risks

• Claims volumes could remain under pressure from economic weakness
• Unemployment could stay elevated limiting the number of workers comp claims
• Interest rates could decline increasing the under funded amount of the pension liability
• Revenue can be lumpy due to large projects in the legal division and weather events - both could be unfavorable to CRD in 2011
• Strong U.S. dollar
• Potential insider selling

Catalyst

Catalysts

• Continued generation of earnings will demonstrate to the street that the underlying earnings power is worth at least 10x earnings
• Pay down the under funded pension liability
• Continue to generate cash flow
• Research could be picked up by another sell side shop