Description

Philadelphia Consolidated Holdings Corp is a small property and casualty insurance company that sports an impressive history of growth and strong profitability. The company has achieved this performance by focusing on high-profit niche markets. One of these niches is in the area of professional liability, in which the company writes policies to insure lawyers, accountants, insurance agents, and corporate executives directors against legal liability. Other specialized lines of business include multi-peril policies for non-profit social service agencies, health clubs, condominium owners, mobile home owners, and daycare facilities. The company also provides excess liability insurance to rent-a-car customers through arrangements with various car rental agencies.

Philadelphia Consolidated's history goes back to the 1962, when James J. Maguire, Sr., established the Maguire Insurance Agency. Maguire, who still runs the company as its chairman and CEO, has slowly expanded the company's scope of operations, and purchased the Philadelphia Insurance Company and Philadelphia Indemnity Insurance Company in 1986. In 1993, the company went public at $6.50 a share.

In 1999, Philadelphia Consolidated acquired The Jerger Company, which primarily sells auto and mobile homeowners insurance in Florida, Arizona, and Nevada, and is now called Liberty American Insurance Group.


The senior Maguire still oversees the company, and no fewer than five sons have followed him into the business. The oldest, James J. Maguire, Jr., is now the President and Chief Operating Officer, and another son, Christopher, serves as senior vice president and chief underwriting officer. Altogether, 45% of the company stock is still owned by the family and other company insiders.

The company targets the most lucrative and underserved niches in the insurance markets, and then relies on its product development committee to research the market and come up with a differentiated solution. The company uses a "10 reasons" rule: every new product must have ten advantages over the competition, which ensures that there will be both differentiation and demand for PHLY's policies.

Philadelphia Consolidated's growth has also been consistently excellent. Gross written premiums have more than tripled since 1995, growing from $104.2 million to $361.9 million in 2000. That's an average annual growth rate of 28.3% for the six years. The company's bottom line improved from $9.8 million in 1995 to $30.8 million in 2000, a five year growth rate of 25.7%. The average Return on Equity over the past six years has been 17.5%, especially impressive in light of the fact that the company carries little debt.

Over the last ten years, PHLY has turned in an average combined ratio of less than 90%. Over the same period, the industry average has been 107.6%. (Those of you who own or follow Berkshire Hathaway are no doubt aware of how challenging the property/casualty industry has been in the last two years.)

Within the company's specialty niches, there is plenty of room for growth. Even in commercial packages, which is the company's biggest business, Philadelphia Consolidated has only about 3% of the market. In it's specialty lines, the company has less than 1% market share.

The company is conservatively financed and managed. Philadelphia Consolidated is rated A+ by A.M. Best and A by Standard & Poor's, both excellent ratings. As of December 31, 2000, Philadelphia Consolidated's surplus was $193.3 million. An industry rule of thumb is that a company may safely write up to $3 of new premiums for every $1 of surplus. At Philadelphia Consolidated, the company is currently writing new premiums of about $1.40 for every dollar of surplus, so it's very conservative. Also, the company limits its risk to any single contract to $1 million -- any risk beyond that amount it passes on to reinsurance companies.

At a recent $26 per share, the market cap is around $360 million. That's about 12.5 times 2000 earnings for a company that should easily be able to maintain a 15% growth rate going forward. It's also about 8.2 times 2000 free cash flow.

Finally, the outlook for the insurance industry is improving -- prices are increasing steadily as the industry looks to correct the horrible overall performance of the past several years. In speaking to an officer at the company recently, I was told that the company is getting renewal business on contracts at anywhere between 15% and 40% increases in the premiums.

One item to note: there is very high short interest in this stock, which Yahoo! Finance reports at 43% of float. This is, in my opinion, attributable to the holders of a convertible security that will be converting in May of 2001 to equity. The amount is $103.5 million, and will dilute the shares outstanding by about 28%. It is my guess that some holders of these securities have hedged their exposure by shorting the common. The current float is listed as 3.2 million shares, or about $83 million, so the short position would be equivalent to about $41.5 million. Of course, if I am right, the large short position will then be unwound in May when the paper converts to equity. This conversion will also increase pre-tax earnings by about $7.2 million that the company is paying in interest expense.

Catalyst

CATALYSTS: The possible catalysts for an increase in stock price include continued growth (15% being a low estimate of future growth), improving pricing in the insurance industry, and a very reasonable price for an excellent business.