Description

Summary:

Hub International Limited is an undervalued North American insurance brokerage. The insurance industry, unlike most other industries, has been able to strongly increase prices over the past year. It is expected that the significant decline in capacity, weak reserves and low interest rates will keep pricing growth strong for at least the next two years. By investing in a commission based broker of insurance like Hub, an investor can capture the positives of the currently favorable pricing cycle without exposure to the negatives of the underwriters themselves, including claims risk and interest rate risk. What makes Hub particularly attractive is that it is trading at a large discount to its peers, despite the fact that it is among the fastest growing of the insurance brokers. Hub shares have fallen about 25% since the company’s third quarter earnings release. This was primarily due to management appearing to give some mixed signals about its 2003 outlook. At the time the company was in the midst of budgets and did not want to give an overly optimistic outlook. Expectations were already a little too bullish following a blowout second quarter of $0.41 vs. the $0.20 consensus. Given its expected growth and where its peers are trading, I believe that the stock is worth $20.

Company Description:

Hub International Limited is a North American insurance brokerage providing a broad array of property and casualty, life and health, employee benefits, investment and risk management products and services. The company focuses primarily on middle-market commercial accounts in the United States and Canada, which it serves through its 130 locations, using a variety of retail and wholesale distribution channels. Hub defines the middle market as those clients with 20 to 499 employees. The company was formed in 1998 through the merger of 11 Canadian insurance brokerages. Since that time, it has acquired an additional 78 brokerages and has established a strong presence in the northeastern and Midwestern United States and in the Canadian provinces of Ontario, Quebec and British Columbia.

The mix of products and services the Company offers in the United States differs form those in Canada. In the US in 2001, 83.6% of Hub’s commission income was generated from the sale of commercial lines and 10.0% form personal lines. In Canada in 2001, 47.1% of its commission income was generated from the sale of commercial lines and 44.5% from personal lines. The company generates over 60% of its revenue in the US. Hub is the 14th largest insurance broker in the US and the third largest in Canada.

The Company’s commercial insurance products are comprised of property and casualty, employee benefits and risk management services. Property and casualty products include insurance for business property, auto and trucking fleets, technology, intellectual property, natural disaster, worker’ compensation, liability, surety bonds, business income, accounts receivable and environmental risks. Employee benefits products include group life and health, employment issues, human resources, retirement plans, and contract review. The Company’s risk management services are comprised of claims management, risk finance structuring, exposure evaluation, coverage analysis and contract review.


Valuation:

Hub is currently trading at 10.6 times my 2003 earnings estimate of $1.15, which will be about 17% growth over 2002 earnings. By comparison, the peer group which includes Arthur J. Gallagher, Brown & Brown, and Hilb, Rogal & Hamilton currently trade at 20 times 2002 earning and 16.6 times 2003 earnings. Give Hub a peer multiple and it is over $18 per share, with strong growth still ahead. In fact, Hub should grow at a faster pace than its peers because it primarily works on a commission basis with its clients while brokers that service larger account do a lot of fixed fee deals. Price increases by the carriers therefore grow Hub’s topline more quickly than some of Hub’s peers.

One potential negative of Hub is that it is a roll up. However, it is not a roll up in the Tyco sense of the word. Management has spent their entire careers in insurance, has a disciplined acquisition strategy, and is doing acquisitions of insurance brokerages in order to build geographic presence around North America. Adding offices in new cities is more efficiently done in this industry through acquisition versus starting fresh without a custom base. The peer group is also all roll ups, for lack of a better term, and continues to make numerous acquisitions every year.

Catalyst:

Continued strong earnings performance over the next few quarters should be enough to get Hub a valuation more inline with its peer group and reflective of its economic fundamentals.

Possible takeover target by another company in the peer group if Hub’s discount persists.

Catalyst

Continued strong earnings performance over the next few quarters.

Possible takeover target by another company in the peer group if Hub's discount persist.