Assurant – Q4 2012

Hello world! I’m almost fully invested and do not find any new wonderful stocks so I keep track of my actual holdings. This week, Assurant inc released their forth quarter results. I will try to highlight my major findings.

Share repurchase slowed in Q4 but not willingly. There is still 500m left in the repurchase authorization.

Share repurchases and dividends totaled $472 million for full-year 2012. Dividends to shareholders in 2012 totaled $69.4 million. During 2012, the Company repurchased 11 million shares, or 12 percent of its common stock outstanding at the end of 2011, at a cost of $402.7 million. Early in the fourth quarter, Assurant repurchased 852,000 shares of its common stock for $33.4 million. Superstorm Sandy made landfall Oct. 29, 2012. Pending loss estimates, Assurant did not implement a new share repurchase program. By the time a loss estimate was announced Dec. 18, 2012, the Company was in an earnings blackout period. Assurant has $503 million remaining in the current repurchase authorization.

ROE is stable and at industry average. By paying less than book, we get a great return.

Annual operating return on average equity (ROE)3, excluding AOCI, was 10.4 percent in 2012

Book value increased 13%.

So my original investment thesis remains intact and the future looks bright!

disclosure : Author is long AIZ.

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Portfolio performance – 2012

My 2012 performance is now updated in “Portfolio performance”. I do think this year was rich in lessons learned with Gencor value trap and biggest lesson of all Fortress Paper overpromises.

FTP falling more then 70% this year contributed to -30% in my portfolio. A good thing all other stocks rocketed (BAC, AIG, LACO, PSD…). The total return for 2012 is 6.41% compared to the XSP (S&P edged in CAD) of 13.4%.

100$ invested in Pretoria Investment at my begginings would now be valued at 160$.

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Assurant – book value valuation

Regarding AIZ book value per share.  I looked around and found out that most insurance company are valuated based on book value per share.  Insurance business usually make no to little money on premiums but net incomes are correlated to invested value interest income (interest on book value).  If you get a return based on the book value, it is interesting to value your investment on that basis.

Here is Assurant book value per share progression per quarter since 2011.

AIZ-BV

Current book value is 53.70 excluding AOCI giving us a P/B of 0.64.

The book value is progressing, thanks to massive (10%) share repurchase program on going, between 14% (2011) and 18% (2012 YTD).  Let’s assume a 10% growth in BV and we get this valuation.

I think I’m falling in love with AIZ.

Disclosure : Author is long AIZ.

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Assurant (AIZ)

It is my second time trying to valuate an insurance company.  As this blogs relates my expedition in value investment, I’ll try to write down my thoughts in valuating an insurance company.  This valuation is directed at Assurant.

Company description

Assurant is an insurance company with multiple segments.  I like to evaluate risks and revenues by segment in any business so I’ll try to value Assurant this way.

Assurant Solutions

This business segment provides debt protection administration, credit-related insurance, warranties and service contracts, and pre-funded funeral insurance.

Assurant Specialty Property

This business segment can further be split in lender-placed homeowners insurance and manufactured housing homeowners insurance and most recently speciality home insurance like flood insurance.

Assurant Health

It provides individual health and small employer group health insurance.

Assurant Employee Benefits

Primarily provides group dental insurance, group disability insurance, and group life insurance.

Financials

Regarding insurance financials, we need to read the financial statements in a different way a normal industrial business financials would be read.  You got the « premium » section and then you’ve got the « Benefit, losses and expenses » section.  It looks like the « revenue » and « cost of revenue » of an industrial business but it is not really the same thing.

Premium

In the premium section of the financials, you got all the premium revenues received from insured persons or institutions.  You also have the interest earned from these premiums (you pay your insurance before the accidental event occurs, example death).  In the case of Assurant, they also provide services related to their insurance like loan portfolio monitoring or claim management.  This revenue is also included in this section.

Benefit, losses and expenses

This relates to the actual policy holders claims in the current year, the depreciation regarding insurance portfolio or business acquisition.  These two expenses are mostly uncontrollable by the insurance business expect by better managing insurers evaluation.  Then comes the Underwriting expenses.  These are related to commissions, fees, linked to obtaining the insurance contract.  At Assurant, the commissions are calculated on net revenue from premium so they are closely linked to the net income.  If the net income goes down, those fees will surely fall too.  That is an interesting point.

Ratios

I’m not usually a big fan of ratios but I try to value an insurance business and it seems to me that 3 ratios really are crucial in insurance company valuation.

Loss ratio : total Benefits given to insurance owners divided by the premiums paid.

This ratio should give plenty of room for expenses and should be consistent through the years if the insurance premiums charged are fairly valued.

Expense ratio : total premiums earned divided by Underwriting expense.

This ratio covers commissions and other fees for acquiring premiums compared to the premiums received.  If you’ve got cost flexibility, this one should stay fairly stable over time but if you have no flexibility (vendor salary, cars, rents, etc.) this one will vary wildly through the years.  I, personally, would prefer a stable ratio in valuating an insurance company.

Coverage ratio : total net premium divided by total benefit, losses and expenses.

This one gives us the profitability of the overall insurance operation.  A total ratio under 100% results in a profitable business segment.  Otherwise, you need other incomes to compensate the losses.  In good years, it should be under 100%, in bad it can go over 100% resulting in interest covering higher expenses instead of generating profit.  Do not forget that the coverage ratio does not include full revenues (related services and net interest income are not part of the regular coverage ratio) but only premiums.  In Assurant financials, they utilise full revenue in the coverage ratio.  I’ll remove those values from the ratio to get a clear view of the financials through the years.

AIZ-ratio

As we can see, AIZ coverage of premiums is not so great.  It evolves around 105 and 110 for the last 2 years.  I assume Assurant priced their related services in the coverage calculation because they integrate their systems to the customer system and charge “management” prices depending on the business segment (ex: warranty claim management on products, lender-placed insurance coverage for bank loans, etc.)  It lowers the coverage ratio to the 100% range.

Regarding total coverage, I think there is a major discrepancy between business segments. So I analysed the profit margin by business segment (total coverage inversed).

AIZ-Margin

This clearly points out the Speciality Property as the main pretax margin driver.

Let’s analyse this segment in particular to ensure this revenue will stay stable through the following years.   This segment is split in 2 major different type of insurance: Lender-placed and Owner placed.

Lender-placed

In the financials there are lots of notes regarding pursuits and business challenge in the lender-placed segment.  California state passed a law that will reduce premiums for lender-placed insurance by 30% starting October 2012.  New York is considering applying the same regulation and other states are considering this regulation too.  Lender placed insurance is the biggest portion of this segment (70%) and will be declining in the short future.

Owner placed

This segment covers special event like flood.  This one is increasing slowly through the last years.  It inscreases less than 5% a year but it proves it should not drop shortly.

Future profitability

We got to restate financials for the next years because we must assume 75% of the lender-placed speciality property will disappear linked to the regulations. So at the current share count, the TTM eps comes at 7.15.  If we removes 75% of lender placed we drop down to 4.66.

AIZ-EPS

At the current price, we can calculate a 14% return yearly or a P/E of 7.3.  But in the previous years, AIZ purchased their own shares.  They purchased deeply!  Around 10% per year.  If we include those purchases, here is the future profit (purchase 10% per year).

What more can we say?

I’ll get in deeper on Assurant valuation, but at these levels I think we can fairly evaluate a great margin of safety on the current share count and a HUGE one if the share purchase continues.

Disclosure : Author is long AIZ.

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DELL follow up

Following last post on Dell estimates, I checked if my assumptions were valid on the quarterly release financials. All expected drop in sales were in line with my estimates but the service growth was not. Even with quest acquisition, Dell did not increase services. I do not know the rationales behind this week Dell’s share price valuation uprising, but I exited my small position at a small (no) profit.

I do think there is value in Dell but I’ll jump back in if my estimates comes true.

Disclosure : none.

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Fortress hit 52 week low

Long story short, everything that could go bad went bad. Company is now burning throught cash, taking debt, talking about buying more and more mills and the market price for DP is dropping like a rock in a no-bottom pool.

Chad may have great ideas but he had a major execution problem on this one. He was too aggressive in currency printer conversion and mill conversion/purchase.

If he manages to get out of this pool, I may get back in. Until then, I’m out of Fortress losing an average of 70% of my initial capital.

Too bad I got in excited by Chad’s pink view of the future. Lessons-learned #2. Buy on actual not estimates.

Disclosure : none.

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Dell : a business in transformation

Dell operating segments

Enterprise solutions
This business is the growing higher margin segment of Dell. They put all hopes on this segment. It grew 14% this year (excluding storage) and they want to fuel this growth in the next years thought acquisitions. A 10% planned growth could be a good expected growth. Cash will be required thought and I do think it can be provided by the declining businesses.

Software and peripherical
This business is tightly attached to product sales. It includes all ‘add on’ that you may include in your computer purchases. If, sorry when, the pc business will be at 0, this one will follow. Assuming a 15% decrease a year is a plausible scenario.

Mobility
This segment represents laptop and other mobile devices. This is a rapidly declining business due to competitors aggressiveness in prices and products. I do think dell missed the emerging market opportunity that existed in the previous years by keeping high margins and high quality. Higher quality products ( read apple ) got the high-end market and massive lower grade products ( read acer, asus, Lenovo ) captured the low end. They are left with the middle class eroding fast to competitors. The drop is brutal at a major 20% decrease annually. I do assume it will stay this way.

Desktop
While this business line is declining, general public and corporate still order Dell products to fill their home and business with fixed computers. It does goes down, but mainly in prices and not in number of units. It is a good thing assuming warranty services and software segments are closely linked to this segment. I do assume it will go down at a 10%/year rate.

Balance sheet

The 3b net cash is reassuring at first glance but if you look only at last year acquisitions, we shouldn’t be. The acquisition frenzy is on going at the billions dollars shotgun. Will it turn out to be positive? Only future can tell. The current manager now is Michael Dell. He is back for the future. He will try to ‘recreate’ Dell. Will he burn the balance sheet or create a wonderful, cash machine?

Expected profitability

So I am rapidly going into the expected profitability.

Enterprise solutions Enterprise services Software & Peripherals Mobility Desktop PCs Total
Revenues
2012 10 456 8 354 10 272 16 212 13 340 58 634
Yearly change -10% 10% -15% -20% -10%
2013 9 410 9 189 8 731 12 970 12 006 52 307
2014 8 469 10 108 7 422 10 376 10 805 47 180
2015 7 622 11 119 6 308 8 301 9 725 43 075
2016 6 860 12 231 5 362 6 640 8 752 39 846
2017 6 174 13 454 4 558 5 312 7 877 37 376
Profit Margin 18% 30% 18% 18% 18%
Gross margin
2013 1 694 2 757 1 572 2 335 2 161 10 518
2014 1 524 3 033 1 336 1 868 1 945 9 705
2015 1 372 3 336 1 135 1 494 1 750 9 088
2016 1 235 3 669 965 1 195 1 575 8 640
2017 1 111 4 036 820 956 1 418 8 342
Operating expenses 15% 15% 15% 15% 15%
Net profit
2013 282 1 378 262 389 360 2 672
2014 254 1 51 223 311 324 2 628
2015 229 1 668 189 249 292 2 627
2016 206 1 835 161 199 263 2 663
2017 185 2 018 137 159 236 2 736

As you have seen, this is more of a fast first-glance analysis. I think it will help me figure out if I start a position in Dell and continue monitoring the progress or simply pass. A lot of these estimates is exactly what it is named for : guesses. I assume a need for margin of safety with these calculations at least 50%. A lot could go wrong.

Competitors in services are quoted at a P/E around 15 to 20. I assume DELL isn’t worth that until the transformation is complete. Lets assume 50% discount so between 7.5 and 10.

We could get 20b to 27b market value plus net cash of 3b for an expected share price between 13 and 17. We get a 37% to 80% upside.

I think a small investment could be worth the reward.

Disclosure : Author is long DELL.

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