Description
Penn Millers is a small P&C insurance company that trades at 57% of tangible book value and recently demutualized. Looking at the past ten years of experience, there is no reason to invest here, even at the steep discount, but a number of things are changing for the better that should improve PMIC's earnings.
Business: PMIC's primary business is agribusiness, covering processors and manufacturers. They tend to cover middleman operations and not product producers or farms. This represents 60% of the premium volume and the other 40% comes from writing business owners package for small businesses. They did write personal lines but exited that in 2003. They originally insured grain processors, hence the inclusion of "millers" in their name. They do not insure crops or farms on a stand-alone basis.
Agribusiness: Earlier in this decade, Zurich attempted to dominate this fragmented niche. The fierce competition for business resulted in a number of casualties, with Zurich ultimately pulling out and Michigan Millers Mutual experiencing combined ratios over 120%. For now, the weaker players have been removed, which bodes well for more rational pricing. Nationwide dominates the agribusiness space with an estimated 2/3rds of the market. Michigan ranks second and PMIC is a very close third. I have not been able to confirm these market shares. PMIC is the only public company in this space as the rest are mutuals.
Capital Raise: PMIC recently completed a demutualization that netted $45 million in new capital by selling 5,44022 shares. Pro Forma book value is around $102 million, with no debt or goodwill. The new capital will help them in two ways. First, they should be able to reduce the amount of reinsurance they purchase. Due to the high combined ratio from the pricing wars, PMIC has been buying stop loss reinsurance (72% of losses, 92% with expenses). You can get a sense of the impact on p.26 of the recent 12/18/09 presentation:
http://www.sec.gov/Archives/edgar/data/1453820/000095012309071916/w76669exv99w1.htm
The second benefit is that they have the capacity now to write more business in a better market. They recently introduced PennEdge that expands their commercial business to include mid-size accounts. They write agribusiness in 33 states but only write commercial in 8 states. They are mid-way through the roll out of PennEdge that should continue through 2010. Thus, PMIC can leverage its existing agency relationships to also include commercial insurance. Given that they have operated around 1.4-1.5 underwriting leverage, that is premiums to equity, they have the ability to increase premiums written by 75-90%. This will allow them to also leverage their fixed expenses, as management has indicated that they have most of the staffing needed to support a larger book of business. PMIC can accomplish this without leveraging their balance sheet, as they have no debt.
Investments: PMIC has a conservative investment portfolio. They sold all their common stock holdings in 2008 for a loss and are totally in bonds. The fixed income portfolio is managed by Conning Asset Management. Most of the mark downs in 2008 were on corporate bonds, not RMBS or CMBS, that have since recovered.
Reserves: They had problems in 1999-2002 and have been addressing the underlying issues. They are using outside actuarial consultants to perform more frequent reviews, increased reinsurance and exited certain lines and classes. Accident years since 2004 have all experienced reserve redundancies. There are $2.7 million of asbestos and environmental ("A&E") reserves on the books. Of note, there is no A&E from direct business but all from assumed reinsurance.
Management: Management is relatively new. The CEO is Doug Gaudet who was brought in 2005 to turn things around. He has worked at Philadelphia Insurance Companies, Harleysville Insurance, Crum and Forster and Zurich. Michael Banks was hired in 2002 as CFO. I do not know much about Gaudet and Banks but they have shown some sense in capital uses so far. The IPO was funded through subscriptions from policyholders, who received full orders, and from the community offering whose orders were cut back. There was no syndication and the offering came in a mid-point. PMIC could have raised a lot more capital, if they had wanted, but they only took what they needed. In the process, they kept the stock local and avoided the hot money on Wall Street. They recently announced a 5% stock repurchase. They have also sold two money-losing subsidiaries.
Earnings: There is no visibility on their earnings due to all the changes. This is why it is selling cheap. Looking at ROE, their earnings range is somewhere between 6% to a wet dream 15%. On an earnings per share basis, that equates to $1.12 to $2.80. At 10% ROE, EPS is $1.87. I do not expect PMIC to earn that next year but in 2-3 years. This is a wet paint kind of investment.
Risks:
- Buying turn around stories, particularly in P&C insurance, can be a crap shoot
- Most of their liability coverages are written on an occurrence basis instead of claims-made
- Small and illiquid
Catalyst
There is no research on PMIC because it is small and just recently came to market. There are a number of improvements being made that have yet to be fully developed and past results have been anemic. It will take time and patience for Penn Millers to transform itself, but the discount to book helps.