Arch Capital: Still The Best And Still Undervalued

 

In a still-hot insurance market, a "hard market" in industry-speak, I continue to believe that Arch Capital (ACGL) is not only the best-run company out there, but still undervalued. While I don't typically cite share buybacks as proof of anything, given Arch's excellent historical track record with allocating capital, the fact that the company has been buying back shares at around 1.2x book when they're also underwriting seemingly all the business they can is a strong argument to me.

This hard market won't last, but Arch has always found ways to make money and do right by its shareholders, though it's not a year-in, year-out winner in the stock market. With the shares trading below my mid-$40's near-term fair value, I do think this is a name still worth considering at this level.

 

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Arch Capital: Still The Best And Still Undervalued

Arch Capital Showing The Superiority Of Its Model Yet Again

Few insurers come close to the long-term returns generated by Arch Capital (ACGL), both in terms of total equity return and economic/financial returns, and yet every cycle there are sell-side analysts who decide to tug on Superman’s cape and try to point out perceived weaknesses in the model at that point… only to be proven wrong within a couple of years.

The latest example is the criticism leveled at Arch Capital when they made a big commitment to mortgage insurance and deprioritized primary insurance. While mortgage defaults have indeed spiked in this recession, overall losses are still better than the bears predicted. Meanwhile, insurers who wrote a lot of primary insurance business in the 2015-2018 period are starting to see adverse reserve developments and weak overall underwriting results.

Arch Capital can get pretty cheap every once in a while (as happened in March/April of 2020 and mid-2018), but for the most part investors have to content themselves with prospective returns in the high single-digits to low double-digits. I think that’s a pretty fair return for a superior company, and I still think the shares are worth owning at today’s price.

 

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Arch Capital Showing The Superiority Of Its Model Yet Again

RenaissanceRe Continues To Do Things Its Own Way

I really have to admire a company that gets pushed by a long-term shareholder to conduct a strategic review and sale process only to turn around in less than a month and announce a significant acquisition. With RenRe’s (RNR) acquisition of Tokio Millennium Re from Tokio Marine Holdings (OTCPK:TKOMY), management has made it clear that they continue to see more value for shareholders as an independent company and that, like it or not, they’re going to run the company more or less the way they always have.

I’ve been a long-term admirer of RenRe, so I really have no problem with this decision. Although there is still considerable uncertainty in the market over Jan 1 reinsurance renewal pricing, I think RenRe is sitting in a relatively comfortable (if not good) position as a ready and willing supplier of capacity at the right price, and I believe the TMR transaction is a low-risk deal that could offer double-digit accretion as it plays out.

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RenaissanceRe Continues To Do Things Its Own Way

Everest Re Looking A Little Better, But Reinsurance Rates And Loss Trends Still Up For Debate

I thought Everest Re (RE) looked a little too beaten down back in August, largely on outsized worries about management’s ability to asses and price risk, particularly given significant growth in reinsurance underwriting. Since then, the shares have done a little better than most of its peers including Arch Capital (ACGL) and AXIS (AXS), though hasn’t quite kept pace with RenRe (RNR) and the company’s trailing twelve-month performance looks a little better relative to the S&P 500 than it did before.

Four months doesn’t really change all that much, but I do believe the outlook for cat reinsurance pricing is a little better now, and I think Everest Re has laid out a believable case for growth through targeting opportunities in specialty/niche insurance and harder markets in the reinsurance business. Reinsurance pricing is clearly a wildcard, as is the demand for insurance-linked securities (where Everest has a meaningful presence), and I think the company’s estimates for fourth quarter cat losses could skew high, but the shares still look valued attractively enough to consider buying and holding.

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Everest Re Looking A Little Better, But Reinsurance Rates And Loss Trends Still Up For Debate

Market Skepticism On Mortgage Insurance Still Offering Some Upside In Arch Capital

Arch Capital (ACGL) has had a challenging trailing 12 months, with many investors still not convinced that the company’s major foray into mortgage insurance will prove to be a value-creating move over time, and ongoing concerns about the change in management and the returns available in primary insurance and reinsurance. With that, Arch Capital’s double-digit decline over the past year doesn’t stack up very well next to the performance of Everest Re (RE), RenRe (RNR), or W.R. Berkley (WRB).

I am a little concerned about the uptick in primary insurance core losses, but I believe the Street is still undervaluing the company’s mortgage insurance business and the value Arch can generate from third-party vehicles like Watford and Bellemeade (the second-largest sponsor of insurance-linked bonds behind Everest). With a fair value of around $30, I don’t think Arch Capital is radically undervalued, but I think these shares can offer a solid high single-digit to low double-digit annualized return from here.

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Market Skepticism On Mortgage Insurance Still Offering Some Upside In Arch Capital

Arch Capital Reports Another Good, Balanced Quarter

All in all, business continues to go well for Arch Capital (ACGL). The Street seems a little more rational about the company’s mortgage insurance business relative to just a month or two ago, while the insurance business continues to do well relative to an environment with rising claims expense. This wasn’t the sort of result that’s going to change minds on the stock though. If you liked it before, you’ll almost certainly still like it and if you didn’t like it before, I’m sure you’ll work up some justification for that too.

As far as valuation goes, the 15% or so move from recent lows takes it out of “can't miss” territory and more into “decent long-term hold” territory. At this price, I believe investors can expect a high single-digit total annualized return, which isn’t bad from one of the best-run insurance companies out there.

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Arch Capital Reports Another Good, Balanced Quarter

RenaissanceRe's Strong Risk Modeling Comes Through Yet Again

Maybe it sounds obvious, but the ability to adequately model, measure, analyze, and price risk is a major strategic asset for an insurance company, and one that has served RenaissanceRe (RNR) (“RenRe”) and its shareholders very well over the years. That risk management skill came through yet again for the company in the second quarter, with lower loss experiences from last year’s natural disasters leading to a big reserve release this quarter.

I don’t expect another reserve release like this again in the near future, and the fundamental problem of weak pricing in reinsurance remains (particularly in cat-exposed business). RenRe has been harnessing its fundamental skills to expand its casualty and specialty businesses, where the risks are often harder to model, the needs of customers are much less “off the rack,” and where good pricing is still available.

With the shares having sold off since my last piece (even with a sector-wide rebound off late June lows), the valuation is a little more interesting – RenRe isn’t exactly dirt cheap, but the shares are trading below my assessment of fair value, and buying well-run companies below their fundamental value usually has a way of working out.

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RenaissanceRe's Strong Risk Modeling Comes Through Yet Again

Improving Pricing And Good Investment Returns Supporting W.R. Berkley

Given the historical returns that W.R. Berkley (WRB) has generated, betting against management is not something to be undertaken lightly. I'm not exactly doing that, but I do believe the company is facing a tough combination of claims inflation, smaller surplus reserves, and a more challenging investment environment that improving pricing can't completely offset. W.R. Berkley's historical performance arguably deserves the premium it gets, but I can't really see much value in the shares at today's level.

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Improving Pricing And Good Investment Returns Supporting W.R. Berkley

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

Arch Capital Sticking To Its Guns, But The Street's Unimpressed

You might think that a company with a long track record of strong results would get more benefit of the doubt, but the Street just doesn’t seem to want to buy the Arch Capital (ACGL) story, or its shares. Although the housing market is strong and regulatory changes to the mortgage insurance industry would argue for better returns, while the P&C and reinsurance industries struggle with inadequate pricing power, analysts and investors just don’t want to pull the trigger.

I believe there continues to be an attractive long-term opportunity in Arch Capital shares. The heavy weighting of the mortgage insurance business does indeed change the company’s long-term outlook, but that’s not necessarily a bad thing. In the meantime, the company continues to look for ways to generate acceptable returns in its insurance and reinsurance operations, while maintaining long-term flexibility in the pursuit of double-digit ROEs. With the shares undervalued below $30, I still find these shares attractive.

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Arch Capital Sticking To Its Guns, But The Street's Unimpressed

Sluggish Rates And Book Value Growth Limit Renaissance Re's Appeal

I wasn’t overly excited about the prospects for the shares of Renaissance Re (RNR) (“RenRe”) back in the fall of 2017, as I was concerned that renewal rate increases would disappoint even after a bad catastrophe year and that RenRe would be facing a combination of weak book value and ROE performance. RenRe shares have indeed underperformed since then, falling almost 10% since that last article (though outperforming Arch Capital (ACGL) and Lancashire Holdings (OTCPK:LCSHF) (another reinsurance/specialty insurance company with meaningful property exposure)) and slightly more over the past year.

Weak rates have indeed remained the story, and with that weak momentum in book value growth (actual contraction for three straight quarters) and barely double-digit near-term ROE prospects. While RenRe remains a great reinsurance company, with upside in the casualty/specialty business and its third-party capital management vehicles, it’s likely going to take a little longer to unlock that value and investors have to contend with the risk that over-capitalized markets will be the “new normal” for a longer time, keeping a lid on RenRe’s rate growth prospects and returns.

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Sluggish Rates And Book Value Growth Limit Renaissance Re's Appeal

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

Arch Capital Sliding Back To An Interesting Long-Term Valuation

Although Arch Capital (NASDAQ:ACGL) remains a very well-regarded insurance company, the last year hasn't been so friendly to this company or its peer group. A lot of contributing factors have been at play, including large cat losses in 2017, rising costs, regulatory/competitive changes and so on, pushing the shares down more than 10% and below the performance of peers like Everest Re (NYSE:RE), RenRe (NYSE:RNR), and W.R. Berkley (NYSE:WRB).

When I last wrote about Arch Capital, I said I preferred to wait in the hopes of getting an opportunity to buy the shares in the mid-to-low $80's. That opportunity has arrived, even though analyst estimates have continued to head higher. While these stocks generally don't perform especially well during periods of higher rates (which may seem counter-intuitive given the benefits to their investment income), and pricing power is still limited, I think this may be an opportunity to start a position. Arch Capital looks priced to generate double-digit annual returns from here and this has been one of the best-run insurance companies in the business - a trend I expect to continue, and to continue to benefit shareholders, into the future.

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Arch Capital Sliding Back To An Interesting Long-Term Valuation

Everest Re's Strong Reinsurance, And Improved Insurance, Operations Are Building Value

Everest Re (NYSE:RE) has long had a very good reinsurance business - although skewed toward property-catastrophe, the company’s focus on specialty/smaller lines and low overhead costs have helped generate pretty good returns even through recent weakness in pricing. What has been more impressive, though, has been the improvements in the insurance business - a business that management had elected to continue growing aggressively despite a pretty poor history of underwriting losses.

Everest Re management has done a lot to repair investors’ opinion of the insurance operations, and the company has also managed to benefit from M&A-driven dislocations in the market. Now, with insurance prices showing a little strength and higher rates supporting better investment returns, it’s not a bad set-up for the company. Between the too-high highs of last summer and the too-low lows of this past winter, I think Everest Re is more reasonably priced now, but “reasonable” in this case still suggests a total expected annual return in the low double digits.

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Everest Re's Strong Reinsurance, And Improved Insurance, Operations Are Building Value

RenaissanceRe's High-Quality Model Serving It (And Investors) Well

Hard times tell you a lot about companies, and the combination of a very soft pricing market and recent catastrophe losses have highlighted a lot of what is good about RenaissanceRe (NYSE:RNR). While the shares have certainly lagged the S&P 500 over the past year, and lagged rival/peer Arch Capital (NASDAQ:ACGL), RenRe hasn't done poorly relative to other insurers like Everest Re (NYSE:RE), Aspen (NYSE:AHL), or Validus (NYSE:VR). Throughout this tough period, RenRe's underwriting standards, strong balance sheet, and business flexibility have served the company well, despite some erosion in underwriting profitability.

RenRe is trading at a premium relative to long-term valuation norms. Some of that can be attributed to what I believe is a legitimate and well-earned quality premium, but I do have some worries that investors have been too eager to factor in the benefits of harder insurance markets. While I do still see some upside for shareholders from here, I'd be cautious about establishing a big new position at these levels.

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RenaissanceRe's High-Quality Model Serving It (And Investors) Well

Arch Capital's Cycle-Management Capabilities Serving It Well

Arch Capital (NASDAQ:ACGL) continues to demonstrate why I regard it as among the best of the best insurance companies in the market. While the company's acquisition of AIG's (NYSE:AIG) mortgage insurance business (United Guaranty) was perhaps not universally lauded, I believe investors who understand the dynamics of the mortgage insurance and Arch Capital's strategy here will appreciate the value that it will add in the coming years - particularly as available returns in the primary insurance and reinsurance market are pretty lousy.

Arch Capital shares are up another 20% or so from when I last wrote about the company, beating broader insurance stock indices (like the Dow Jones U.S. Select Insurance Index) and other quality insurers like Chubb (NYSE:CB) and W.R. Berkley (NYSE:WRB) (XL Group (NYSE:XL) has done a fair bit better). The shares certainly aren't cheap on a conventional book value multiple basis, but I do believe and expect that Arch Capital's diversification into mortgage insurance and careful management of its insurance and reinsurance businesses can support high single-digit to low double-digit growth at a time when many other insurers are going to be hard-pressed. Granted, I don't think these shares are undervalued on a discounted earnings basis either, but they're not out of line if you believe in management's guidance and this management team has given investors few reasons for persistent pessimism.

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Arch Capital's Cycle-Management Capabilities Serving It Well

Another Potential Masterstroke For Arch Capital

About as close as I'll probably ever get to gushing over a company is when I talk about Arch Capital (NASDAQ:ACGL). I have followed this insurance company for a long time now (selling the shares a long, long time ago deserves an entry for me in the Great Moments In Idiocy hall of fame), and have always been impressed by the company's keen focus on disciplined, profitable underwriting and unrelenting pursuit of good returns on shareholder capital. That's not always so easy to do in the insurance business, as the ongoing price erosion in property & casualty and reinsurance shows.

Arch Capital has generally avoided M&A, arguing that there are few companies out there with the cultural and quality fit worth buying, and those that are out there tend to be expensive. Arch Capital found a big exception in August, though, when it agreed to acquire United Guaranty from AIG (NYSE:AIG) and vault itself to the top of the list in mortgage insurance. This deal substantially improves the long-term prospects for earnings growth and good returns on equity, and while I don't think Arch Capital is particularly cheap (a familiar problem), it's worth keeping a careful eye on in case a sell-off creates an opportunity.

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Another Potential Masterstroke For Arch Capital

Seeking Alpha: Endurance Specialty Pushing On Through Soft Markets

Endurance Specialty Holdings (NYSE:ENH) hasn't emerged as a leader of the insurance pack, but it has done okay since my last write-up on the company in June of 2015. With the shares up around 5% (excluding dividends), Endurance has outdone the likes of Aspen (NYSE:AHL) and XL Group (NYSE:XL), but hasn't quite kept up with top-notch players like Arch Capital (NASDAQ:ACGL), RenRe (NYSE:RNR), W. R. Berkley (NYSE:WRB), or Hartford (NYSE:HIG).

In my opinion, Endurance has gotten itself off to a good start with the integration of Montpelier Re (NYSE:MRH), and I like how the company has been repositioning its business and risk exposures in the reinsurance segment. On the insurance side, the company is writing a lot of business and looking to grow in markets like aviation and international casualty. While a drive for scale is understandable, expanding the business in a period of soft rates carries with it some risks to future profits.

The market has established an undesirable trade-off for me within the insurance sector - the stocks I like best aren't very cheap (if cheap at all), and the ones that are undervalued have some risks and "yeah, but..." attached to them. Such is the case with Endurance. I don't think my expectations are all that ambitious (long-term earnings growth around 5%, with a 10% ROE) and the fair value of $67 to $70 holds some appeal, but I can't muster together a rousing Buy case for the stock right now.

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Endurance Specialty Pushing On Through Soft Markets

Seeking Alpha: Struggling Genworth Not Close To Earning Its Cost Of Equity

There are many ways to analyze, evaluate, and value companies and they all have their particular advantages and disadvantages. As a general rule, though, I don't think many investors will argue that in order for a stock to be an attractive long-term investment candidate, the company needs to earn its cost of equity (as opposed to its overall cost of capital). That's a big problem for Genworth (NYSE:GNW), as this struggling insurance company is likely looking at many years of single-digit returns on equity versus a cost of equity that is in the double digits.

Management has lost a lot of credibility and goodwill with its various false starts and head fakes as it has tried to repair its struggling long-term care business and improve its life and annuity operations. The latest plan, centering around an attempt to isolate that troubled LTC business, makes some sense, but successfully executing the plan is far from certain. I think the company can generate the cash it needs to manage its 2018 debt maturities, but the risks to shareholders are mounting and although mid single-digit ROEs can support a fair value that's 40% or more above today's price, more stress to the balance sheet could conceivably wipe out much (if not all) of the value.

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Struggling Genworth Not Close To Earning Its Cost Of Equity