Kemper Managing Through A Tough Situation, But Catalysts Still Lacking

When writing about Kemper (NYSE:KMPR) back in March, I said that I saw long-term value in the shares of this beaten-up non-standard auto insurance underwriter, but that the near-term prospects weren't so attractive as the company would continue to face elevated claims expenses and inadequate rate relief. So it has been, with the shares down another 10% on ongoing operating losses despite some progress on non-rate mitigation efforts.

I believe Kemper can return to profitability in FY'23 and double-digit ROE in FY'24, but is still going to require further rate hikes, and there's no guarantee that regulators will cooperate. Better-than-expected losses don't appear to be enough for the Street for now, and I do think the company will need to announce more progress with rates in California to really shift sentiment. For long-term value hounds, I still see some attractive long-term upside, but the risk of these shares heading back to $40 or below before that recovery is not insignificant.

 

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Kemper Managing Through A Tough Situation, But Catalysts Still Lacking

Kemper Hit Hard As Claims Cost Rise Much Faster Than Rates

 

One of the challenges in the insurance sector is that companies price policies based upon forecasted losses, and if those losses exceed expectations, it takes time for rate corrections to patch the gap. That's even more true in the auto insurance space, where regulation can lead to longer gaps between actual loss experiences and rate changes (particularly when companies push for higher rates).

In a nutshell, that remains the biggest challenge for Kemper (KMPR) today.

Kemper saw even worse claims losses in the second half of 2022 than I'd expected, and the outlook for the next couple of years is pressured by rising claims severity and what will likely prove to be some sluggishness on the rate side, particularly in California. That all has contributed to a very weak stock since my last update. Although I do think Kemper can get back to more typical profitability in 2024 and the shares remain undervalued in the meantime, it's hard to find a catalyst for the shares without better-than-expected improvement in rates or losses.

 

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Kemper Hit Hard As Claims Cost Rise Much Faster Than Rates

Kemper Hammered With Higher Losses, But The Longer-Term Value Is Still Meaningful

 

The first half of 2021 has been brutal for Kemper (KMPR), with increased claims frequency and severity decimating the profitability of the company’s core auto insurance businesses. Although Kemper can withstand these losses and is already taking steps to mitigate the impact of claims inflation, it’s going to take a few quarters (at least) to get it sorted out, and I would expect a lot of investors to stay on the sideline until they do.

Bulls can argue that this is just an adverse part of the cycle, that Kemper’s reserves will hold up, and that this could actually force more opportunistic players out of the market, improving Kemper’s long-term growth opportunities. Bears can argue that Kemper is taking bigger hits than other underwriters, undermining the claim to superior underwriting, and that the business is likely to remain very competitive.

I’m still largely with the bulls. I think Kemper got caught in a tough squeeze, where it saw rising losses but couldn’t raise rates fast enough to compensate (due to regulatory issues). Investors shouldn’t ignore the risk of worse losses over the next few quarters, but 1x book is too low for a profitable insurer and I believe more risk-tolerant investors may want to take another look here.

 

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Kemper Hammered With Higher Losses, But The Longer-Term Value Is Still Meaningful

Kemper Under Pressure On Multiple Fronts, Obscuring The Core Value Of The Franchise

Non-standard auto insurer Kemper (KMPR) has had a rougher time of it over the last two and a half years than I'd expected. While I thought the valuation was a little demanding back in 2018, I didn't expect basically flat performance since then and a meaningful lag versus larger auto insurance names like Allstate (ALL) and Progressive (PGR).

There have been setbacks along the way, but I take a little comfort in the fact that they've largely been outside of management's control - lower yields on the investment portfolio and higher COVID-19-related mortality prominent among them. In terms of core underwriting performance, there hasn't been much to complain about, and I believe that's the real story.

I believe that Kemper can continue to gain share in its core non-standard auto market, driving long-term earnings growth in the high single-digits, as well as getting an eventual boost from higher rates and more normalized returns in the life insurance business. It's a riskier than average stock, but I think the double-digit long-term prospective returns are worth it.

 

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Kemper Under Pressure On Multiple Fronts, Obscuring The Core Value Of The Franchise

Kemper's Self-Improvement Plan Is Generating Strong Results

I liked Kemper (KMPR) earlier this year and saw strong potential as the company continued its turnaround efforts and moved toward the completion of its acquisition of Infinity, but I frankly underestimated the scope of near-term growth and underwriting improvement potential for the company’s core non-standard auto insurance business. And so while I liked the stock back in April, I wasn’t counting on a 33% move in the stock in such a relatively short time – then again, neither was the Street, and analysts have been moving their estimates higher pretty steadily.

Although I do think Kemper shares are a little pricey now on a core discounted earnings basis, a mid-teens P/E (in line with post-merger EPS growth prospects) to 2019 earnings can support a fair value in the $80’s and I wouldn’t be quick to assume that Kemper doesn’t have a few more beat-and-raise quarters up its sleeve. Higher cat losses remain a risk and the company has work to do in areas like commercial auto, but this is still a pretty interesting growth insurance stock.

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Kemper's Self-Improvement Plan Is Generating Strong Results

Execution At Kemper Still Offers Upside

A lot has changed at Kemper (KMPR) since CEO Joe Lacher was brought in to turn around this lackluster multi-line P&C and life insurance company late in 2015. While the company is by no means an industry leader in terms of its profitability, management has already delivered progress on improved underwriting quality and is in the midst of an acquisition that should meaningfully improve its position in the fast-growing non-standard auto insurance market.

Valuing Kemper is a little challenging, in part because the company’s ability to successfully integrate its acquisition and continue to improve underwriting quality are significant swing factors in the valuation. Today’s premium to book value of 1.4x looks fair in isolation, but this could readily be a $75 stock in a couple of years if management continues to execute well.

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Execution At Kemper Still Offers Upside