December 18, 2009 - 12:13pm EST by
2009 2010
Price: 8.62 EPS $1.25 $1.25
Shares Out. (in M): 2 P/E 7.0x 7.0x
Market Cap (in $M): 21 P/FCF 7.0x 7.0x
Net Debt (in $M): 11 EBIT 6 6
TEV ($): 32 TEV/EBIT 5.8x 5.8x

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What's not to love about an insurance company trading with a 7% dividend yield and at less than half of tangible book!  I apologize up front for the small cap nature of this idea and limited float but I was looking for an insurance company to do something entrepreneurial with and came across this and it is a great PA or smaller account investment.   I typically have posted larger ideas so please forgive this one.

Now for the idea:  NSEC is a family run, short tail p&c insurer with a history of conservative reserving and paying out a high percentage of profits in dividends.  Half of the stock is controlled by the family, board, and people close to the board so there is no chance this can be taken over unfortunately.  The company was founded in 1958 and 10% of the revenues are from life insurance, 40-50% from wind and fire insurance, and 40-50% form home owners insurance.   With regard to the family, they have treated equity holders fairly in the past returning capital (paid dividends for 32 consecutive years), not paying executives very much (sub $300k for the CEO), and not issuing lots of options.  There are 2,466,000 shares outstanding and book value per share is $16.38 ($40.4mm).  The number of shares outstanding does not go up. 

Almost all of their earnings come from wind and fire insurance on sub $100k houses in the southeast so there is not much competition from large players.  All of their agents are independent and the homeowners business is less than 10 years old and not profitable.  They are trying to get it up to scale but will exit the business if can't get a 10+% ROE in it.  Importantly, 70% of their claims are paid out within a year and 100% within four years so inflation will not hurt them badly.  The combined ROE isn't stellar, but the ROE of the profitable business is and I believe the ROE will trend up to the low teens over time.  They claim this is their target and will exit underearning businesses.   Once again, the wind and fire business which represents 40-50% of the revs represents upwards of 100% of the profitability so since the ROE on these lines is high it is likely worth tangible book.

They target a sub 100 combined ratio and in wind and fire is in the low 90's and homeowners is in the low 100s.  They started homeowners from scratch in 2000 so are still learning.  They usually have excess reserve releases but a couple of years ago got whacked by hurricanes so had to cut their dividend from $.90 to $.60.  They are rebuilding capital right now.  They say they will make a decision on exiting homeowners in the next 3-5 years or selling it if can't figure it out. 

What else do they own?  2750 acres of timberland carried at $1mm but worth much more.  In a fire sale, they think they could get $5mm but think in a few years will be worth $8-10mm.  Timber sells for $2000-3000 an acre and at peak their land would have $3500-4000.  If they get $8mm for it in a few years, this will increase their book value $5mmish after tax.  That is another $2 a share and they plan to sell it.

Their tangible book is $16, but it is understated by the timber and excess reserves (family run insurers are smart to overreserve to limit their tax bills-look at their historical results).  Also included in the book is the company's owned offices which I value at book (though likely worth more as gross PP&E is $6mm, net is $3mm).  I spoke with the CFO and the family is mindful of earning a high ROE and will use their excess capital to do so over time.  They would cut the dividend and buy in stock but older family members want the yield. 

So, what is there to lose in buying a well run insurer with an 7% dividend yield at $8 a share with a mark to market tangible book value of $18-19 a share.  I think the only risk is they LBO the company and take out shareholders at a low valuation.  They are spending $400-500k a year pretax to be public so this would not be a crazy move.  They seem to know their shareholder base well and have only 1500 holders so they may not be willing to ruin their local reputation to takeout holders and other insurers could jump in with counter bids but this is still a risk.  Inflation should not be a problem for them as the duration on their investment book is short and the liabilities are paid out extremely quickly.

Over the next few years, I expect them to sell their timber at $3000ish an acre which will increase book value by $5mm and then to shut down the other business if they can't get it going and distribute that capital.  What will be left is a low teens insurer with a decent business model that should be valued close to tangible book.  You get paid 8% to wait and will likely get $20 a share in a few years.  The IRR on this works out to 30%+ if the stock goes up to a $20 book value at the end of 4 years.


No imminent catalysts unfortunately but timber sales, stock buybacks, dividend increaes, an exit of the homeowners business, or a company sale would all help!

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