Hartford Financial: Making Its Go-It-Alone Case, But The Market Hasn't Really Rewarded It

 

When I last wrote about Hartford Financial Services (HIG) ("Hartford"), Chubb (CB) was making its play to acquire the company, and I said that Chubb would likely have to go to $70/share or higher to get a deal done. As later revealed by Hartford, Chubb did go to $70, but Hartford wasn't interested and management has made it clear that they don't regard the company as for sale.

For the most part I think that any company should be for sale at the right price, but I think Hartford has some legitimate internal value drivers that aren't being fully appreciated by the market. Granted, the shares still trade quite a bit higher than they did before the Chubb bid, but I still see 10% or better annual appreciation potential here if Hartford can generate mid-single-digit core earnings growth … and I think they can.

 

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Hartford Financial: Making Its Go-It-Alone Case, But The Market Hasn't Really Rewarded It

In A Tougher Market, W.R. Berkley Has Outperformed

Insurance stocks are not in favor, with well-run companies like Arch Capital Group (NASDAQ:ACGL) and Chubb (NYSE:CB) looking at double-digit year-over-year price declines in their stocks, while Hartford Financial Services Group (NYSE:HIG) and Travelers (NYSE:TRV) are down more modestly. W.R. Berkley (NYSE:WRB), though, keeps on keeping on, with the shares up about 5% over the past year - weaker than the S&P 500, certainly, but above the sector averages for insurance in general and P&C insurance in particular.

This is a tough stock to recommend. While management has put up a very strong track record, and I like the company’s diverse specialty and small-client exposure, as well as its closer-to-the-client decentralized model, I’m concerned about the long-term impact of claims inflation and today’s valuation. I’ve learned over the years not to bet against W.R. Berkley, and the company’s strong investment operations can generate income growth at a time when underwriting profit growth is more challenging, but it’s hard to favor this pricey-looking name when there are rivals trading at what look to be substantial discounts to long-term fair value.

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In A Tougher Market, W.R. Berkley Has Outperformed

Hartford Undervalued And Improving In A Sector That Seems Adrift

Cheapness, relative, or absolute, rarely moves stocks all on its own. More often, it requires a meaningful change in the trajectory of the underlying business (the dreaded overused and misused word "catalyst") or in the perception of the overall sector. In the case of Hartford (HIG), management has done some good things lately - selling the Talcott business, raising prices, and boosting overall underwriting profits - but the larger P&C sector seems to be drifting without much real pricing power and worries about weaker reserves and rising claims inflation.

I continue to believe that Hartford is undervalued and worth owning, but I can't say with much confidence that it's going to be a near-term outperformer. It will take time for the market to fully reward the emerging underwriting profitability improvements and likely even more time for investor love to rotate back to insurers.

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Hartford Undervalued And Improving In A Sector That Seems Adrift

Argo's Top-Line Growth Is Exciting, But ROEs Remain Lackluster

Argo Group (ARGO) has been a frustrating insurance stock to follow for some time, as the company's strong niche underwriting capabilities and meaningful earnings potential have been held back by persistently high expenses. Reinvesting in the business has started to pay off in terms of premium growth, but solid book value growth and ROE improvement have remained elusive.

Even so, Argo has been a strong performer this year, with a roughly 15% year-to-date gain that leaves comps like AIG (AIG), Alleghany (Y), Chubb (CB), Hartford (HIG), and W.R. Berkley (WRB) well in the dust. While stronger than expected first quarter results helped fuel the surge, and I'm bullish on the prospects for technology investments to yield more premium growth, I'm not yet sold on the company's ability to drop that growth down through to the bottom line, and so I'm not seeing a significant amount of undervaluation in the shares now.

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Argo's Top-Line Growth Is Exciting, But ROEs Remain Lackluster

In A Still-Challenging Market, Chubb's Strengths Stand Out

Insurance has been one of the worst-performing segments of the finance sector, and Chubb’s (CB) superior quality hasn’t shielded it, as the shares are down about 4% over the past year and down about 10% year-to-date. While claim inflation and lower reserve releases are issues, as is the fact that last year’s catastrophe losses didn’t resolve the excess capacity issue in the industry, Chubb’s market position seems to be affording it above-average pricing power and the company’s capital position gives the company options to fund organic growth, M&A, or capital returns to shareholders.

I believe $145 to $155 is a fair price for Chubb shares, but investors will need to have some patience for this sector to come back into favor, as book value growth reaccelerates in 2019.

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In A Still-Challenging Market, Chubb's Strengths Stand Out

Doubts About Arch Capital's MI Business Have Created A Meaningful Valuation Gap

It has been a pretty mixed year so far for insurance companies, with particular business mixes/exposures explaining a lot of individual performances. Reinsurers like Everest Re (RE) and specialty insurers like W.R. Berkley (WRB) have been doing alright, while broader P&C players like Chubb (CB) and Hartford (HIG) have been a little weak. And then you have the mortgage insurers like Radian (RDN) and MGIC (MTG) that have been having a tougher time of it.

Combing the traits of specialty P&C and reinsurance as well as mortgage insurance, it is perhaps not so surprising that Arch Capital's (ACGL) performance has reflected that blend - Arch has underperformed its non-MI peers but outperformed its MI peers. While I understand some of the Street's anxiety about the mortgage insurance space, particularly now that it's such a large part of Arch's underwriting income, I continue to believe that the shares look attractive on a long-term basis.

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Doubts About Arch Capital's MI Business Have Created A Meaningful Valuation Gap

W.R. Berkley Looking To Better Days, But The Market Is Already There

Commercial insurance companies are enjoying pretty high multiples on an historical basis, even though the market remains concerned about pressure on rates and claims inflation. W.R. Berkley's (WRB) recent performance is part of the reason I harp on valuations - although W.R. Berkley's operating results haven't been bad, the shares have lagged peers/rivals like Travelers (TRV), Hartford (HIG), and Chubb (CB) over the past year.

Looking at 2018 and beyond, I'm not bothered by W.R. Berkley's relative growth prospects. I think the company still has good growth prospects in a range of markets, and the company's more aggressive than average approach to investments (including real estate) has reliably contributed positively to income. My concern remains valuation, as the company trades at a high-teens multiple to forward EPS, and the shares seem to be factoring in a pretty exceptional level of growth.

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W.R. Berkley Looking To Better Days, But The Market Is Already There