“I’ve got friends of mine who live and die by the actuarial tables and I say ‘Hey. It’s all one big crapshoot anywho.’” - Ned Ryerson: Everest Group $EG
Insurance Investigations Part II - Quality Compounder
Hello and welcome back to my new deep dive into the world of insurance. I might be late to the party as insurance companies have had a nice runup, but I’m not against starting a placeholder position and waiting for a dip to buy. My best watchlist is my portfolio, and after investing a placeholder sum, I feel the bias toward listening to earnings calls. After following enough companies for a few years, I am always surprised at the buying opportunities that the market eventually provides in an idiosyncratic downturn, like the ability to buy Dollar Tree at $62 two weeks ago.
There are four insurance companies that are going to be covered in this four part series:
Afficianado’s ChoiceQuality Compounder
Secular Tailwind
Degenerate FinTwit Trash
Today’s insurance company is a little delicate given the recent destruction from hurricane Helene. It might be worthwhile to wait a couple of quarters until we know how much exposure Everest Group (EG) has through their property and casualty division and their reinsurance division. But while I am waiting for clarity on that front, in the meantime EG is a quality compounder trading a price to earnings ratio of 5.5x. Some of their peers trade at a price to earnings ratio of between 7x and 15x.
Everest Group is an example of a company firing on all cylinders, not only are they increasing insurance policy sales, and enjoying a favorably low policy claims period, but as the company invests $37.1 of assets in three-year fixed AA- bonds, they have generated a small bit of alpha compared to their benchmark. By burning the candle on all ends, revenue is up 11% annually over the last 4 years, but profits are up 47% annually over the same period.
But not only has the company been firing on all cylinders, there are events happening beneath the surface that imply an acceleration from here. First, EG has been expanding internationally, and the recent results include the upfront cost of this expansion, but the next two years should demonstrate a return on that investment with the corresponding startup expense already behind them. Second, as EG has grown, their multiples have compressed somewhat resulting in a flat stock price for the last 18 months. If growth continues at a similar rate, but shareholders also receive the benefit of a multiple rerating over the next two years, EG could outperform as their price to sales ratio reverts from 1.0x back to 1.3x or so. Third, insurance is entering their unique cyclicality of a soft market vs a hard market. In a soft insurance market, claims are fewer and policy sales volume picks up. Only if a soft market continues for a few years do profit margins get squeezed, so again, things are looking up for EG for the next two years or so.
The future is so rosy that management even cracked open their piggy banks and bought some shares. For a mature midcap with professional management, this behavior is much more rare than my readers might believe as I focus heavily on small caps with insider buying. Only about 5% of C-suite executives ever buy stock, so having all four senior executives buying in size is a strong statement.
The last two years for Everest Group have been very good. While there were several major international disasters, the EG property, casualty, and reinsurance portfolios outperformed their peers. Is this because of luck, or because of management’s superior risk management? Nobody knows, and that’s the fun of being an insurance investor.
But if performance continues, shareholders could expect about an 11% annual growth in revenues, and when combined with increased profitability but compressed multiples, that resulted in a 17% shareholder return for the last three years. With interest rates falling, multiples reverting to prior levels is a distinct possibility, and could provide an additional 25% to 30% share price increase over the next couple of years on top of the organic growth. That would turn a 17% annual return into a 25%+ annual return if the multiple rerating took two years to realize.
While Everest Group has a strong track record of share repurchases, shrinking the float from 61 million shares in 2009 to 39 million shares in 2022, EG’s management did a seasoned equity offering in 2023 of 3.6 million shares for general corporate purposes. This money was directed toward the previously mentioned international expansion, which is expected to generate positive returns going forward. Management has already reinitiated the share buyback strategy, spending $35 million in Q1 of this year, and $65 million in Q2 of this year.
EG is the 4th largest property and casualty reinsurer. Those of us who have been following value stocks over the years are familiar with Warren Buffett’s enthusiasm for the reinsurance business, and we are also familiar with how many fund managers assumed that reinsurance was easy, entered the market, and suffered terrible consequences. Whenever Warren Buffett is asked questions about new entrants to the insurance market, he always says something along the lines of, good luck, it’s a tough business. EG had $11.5 billion of gross written reinsurance premium in 2023, up from $7.2 billion in 2020, a 12.4% annual growth rate. If EG’s success is due to their skill in risk management, there is no reason to think this growth couldn't’ continue.
This next part is a little wonky on insurance jargon, but regarding risk management, the after tax probable max loss from property insurance in the Southeast U.S. has fallen from 11.6% in 2017 to 6.5% in 2024. This represents an enormous improvement in risk management, precisely in the area where hurricane Helene devastated, the Southeastern U.S.
Still, I think it’s worthwhile to put Everest Group on the watchlist for a dip to buy. While this appears to me to be a quality compounder engaging in aggressive share buybacks, similar to Jackson Financial (JXN), but not as small or undervalued, I expect at least some negative news on the next few earnings calls related to hurricane damage, and hopefully the market will overreact and provide an incredible buying opportunity. I will be keeping an eye on this one.