Description
Endurance Specialty is a Bermuda-based insurance company that is trading at 5.6X 2007 EPS estimates and 1.32X tangible book value, making it a bona fide value investment. It has a $2.2 billion market cap and is fairly liquid. The current price represents an attractive entry point for a stock that could be worth $45 in a year.
History: Endurance was formed by investors led by Aon in 2002. Initially, Aon held a large stake but has since sold its shares in the wake of recent insurance investigations. For further details, I recommend reading the previous three write-ups on Endurance.
Peers: There are four close peers to Endurance: Aspen (AHL), Axis (AXS), EverestRe (RE) and Montpelier Re. The relative newness of these companies is a positive in that they do not have any legacy asbestos and environmental (“A & E”) issues. They are all based in Bermuda, which enjoys a clear tax advantage. Management has guided their tax rate to be in the high single digits. That is important because insurance companies are essentially levered bond funds. As such, any incremental benefit on investment yield, to be discussed in the next section, makes a significant contribution to the bottom line. Here is how the Fab Five stack up as of 5/31/2006:
Metric AHL AXS ENH RE MRH
Shares 97.5 163.6 71.9 65.4 96.8
Equity 2,075 3,645 1,924 4,266 1,200
Pref'ds 222.9 500.0 200.0 0.0 100.0
Intang. 8.2 36.1 65.1 0.0 0.0
Debt 249.4 499.1 447.1 1,005.5 352.2
D/E 12% 14% 23% 24% 29%
M/C 2,113 4,285 2,198 5,847 1,509
06 P/E 6.6 5.6 5.7 7.7 5.9
07 P/E 6.0 5.4 5.6 7.2 5.1
BVPS $18.99 $19.23 $23.96 $65.19 $11.36
TBVPS $18.91 $19.01 $23.06 $65.19 $11.36
P/B 1.14 1.36 1.27 1.37 1.37
P/TBV 1.15 1.38 1.32 1.37 1.37
Div. $0.12 $0.60 $1.00 $0.44 $0.30
Div. Yd 0.6% 2.3% 3.3% 0.5% 1.9%
Cheap 7.5 7.7 7.6 10.6 8.1
I should note that I subtracted the liquidation value of the preferreds from shareholder equity in order to calculate book value available to common. Shares are fully diluted. My cheapness metric is nothing more than the product of current year’s P/E ratio by tangible book value (TBV); it provides a quick to see relative cheapness.
Other comps are ACGL, MXRE, PRE, PTP, RNR, IPCR, ORH and TRH. On all 13 names, the average and median P/E is 6.6, while the average TBV is 1.37X and median is 1.37X. I believe that Endurance can trade at a P/E multiple of 8 to 9 in the 18 to 24 months. They need to grow book and get back to an AM Best rating of “A”; they are currently rated “A-.”
Business: While Endurance might be considered a property reinsurer, their book is evenly split between insurance and reinsurance, and about 40% property, 40% casualty and 20% aerospace and other. The 2005 10-K goes into sufficient detail on what each business segment writes, starting on page 6, that I will not repeat it here. I will also refer you to their recent investor presentation for those that like pie charts and color:
http://www.sec.gov/Archives/edgar/data/1179755/000095013606004150/file002.htm
I would like focus on the recent quarterly earnings report that showed a decrease in premiums. That spooked investors and it concerned me initially while reading the press release. The conference call, mainly the Q&A part, provided details on the dynamics going on. While pricing for property coverage, particularly for catastrophe (“cat”) events, is strong, casualty pricing is weak due to competition. Endurance’s premiums were down in 1st quarter because they non-renewed a casualty (workers comp) treaty and reduced their cat exposures by buying more reinsurance so that another KRW (Katrina/Rita/Wilma) would result in 2/3 the loss. These events do not look positive but they are from a long-term perspective. Endurance is walking away from business rather than underprice it, and they are reducing the amount of capital at risk (management stated that their goal to have only 25% of capital exposed to 1-in-100 year events).
Consideration should be given to the upcoming hurricane season that begins today, June1. July 1 is the second biggest renewal date for insurance in general and is an important renewal date for reinsurance treaties covering wind. Endurance has been increasing pricing for wind coverage and it should be more evident in the next two quarters. There is a lag effect between when an event occurs and when it is priced into the next renewal cycle. I believe better property pricing will begin showing up as corporate risk managers start paying up for cat coverage following last weeks NOAA predictions for the 2006 hurricane season.
One final comment comes from a question posed on the last conference call about the opportunities they see. They always saw themselves as being evenly split between insurance and reinsurance, but it happened that the reinsurance market was attractive when they began. Today, they are being opportunistic in writing DIC (Difference in Conditions) insurance, where they are insuring a specific peril, mostly earthquake in CA and wind in Southeastern US. Modern insurance companies have to be flexible in the business that they write.
Investment Income: This is an aspect that the market has been ignoring. Using a quick yield formula of (investment income – alternative investment returns) divided by quarter ending fixed maturity investments available for sale, the first quarter 2005 yield was 3.95% and as of the most recent quarter, 4.88%. Part of the higher yield comes from investing 2/3 of the fixed maturities in corporate and ABS bonds. They also receive fees from lending out bonds to brokerages. The lending program is about 10% of the fixed income portfolio, and it noted on the balance sheet as securities lending collateral/payable. Assuming 5.0% yield, $4.3 billion of fixed maturity investments, 71.9 million shares and negligible taxes, and the bond portfolio will contribute about $3.00/share in 2006.
Capital Management: Endurance pays a $0.25 quarterly dividend, yielding about 3.3%. Management has in the past bought back stock but suspect any future buys are on hold until they get their “A” rating back.
Insiders & 5% Holders: Two directors and the Chief Investment Officer have made open market purchases in the last three weeks. Insiders have also been exercising stock options and keeping shares net of taxes. Also, Aon still owns 4.1 million warrants, Perry Corp owns about 10%, Fido just under 10%, and Capital Z 8.8%.
Competition: The insurance and reinsurance market is very competitive. After KRW, existing Bermuda reinsurers raised $9 billion in new capital, and an additional $10 billion was raised for new reinsurers backed by the likes of Thomas H. Lee Group, Blackstone, Trident III, Citadel Group, and West End Capital. Plus, Greenlight Capital had its Greenlight Reinsurance in the Cayman Islands operational last year. You can read more at the following links:
http://www.theroyalgazette.com/apps/pbcs.dll/article?AID=/20060215/BUSINESS/102150129
http://www.bermuda-online.org/insurebm.htm
http://blogs.advisen.com/blojsom/blog/default/Hurricane%20Katrina/
http://www.insurancejournal.com/magazines/west/2006/01/23/features/65748.htm
As a side note, Motley Fool has been running some short articles on reinsurers and you can check them out at:
http://www.fool.com/News/mft/2006/mft06050915.htm?source=eptyholnk303100&logvisit=y&npu=y
http://www.fool.com/news/mft/2006/mft06050314.htm
http://www.fool.com/news/mft/2006/mft06021720.htm
http://www.fool.com/news/mft/2006/mft06042619.htm
Risks:
- They are exposed to catastrophe losses, particularly hurricanes. Investing in the P&C industry is volatile and anyone buying in this space should consider limiting their position to between ½ and 2/3 of what they normally would invest. Endurance is a hairier beast than MIGP or AGO but not as bad as TCHC.
- More capital than constraints.
- Additional losses and the inability to raise capital would jeopardize their rating with AM Best; losing their “A-“ rating would impair their ability to write insurance (recent examples are PXT and QNTA).
Catalyst
- Cheap valuation
- Boost from pricing increases to the property lines