Lancashire Holdings (LRE) – Optimism in the face of global calamity

Lancashire Holdings (LRE) – Optimism in the face of global calamity

As an investor, it’s always nice to feel that your companies are doing something good for humanity.

Insurance companies might not be the most obvious candidates to generate such a feeling, but they do play a critical role in helping people to recover from disasters of all kinds.

Through its main platform, Lancashire provides insurance in relation to aircraft (3rd-party damage), energy (upstream and downstream), marine, property reinsurance and terrorism/political risk. In other words – when the worst things in the world happen, Lancashire is there to pick up the pieces.

During Q3 2018, Lancashire paid out on policies in relation to Hurricane Florence and typhoons Jebi, Mangkhut, and Trami.

In addition to its main platform, Lancashire owns a reinsurance platform and a Lloyd’s of London managing agent.

A brief management history

The company suffered a crisis of investor confidence back in 2014 when its founder-CEO Richard Brindle retired, only for him to resurface a year later with a new Bermuda-based (re)insurance company, Fidelis. Brindle remains at Fidelis today as Chairman, CEO and CUO (Chief Underwriting Officer).

Lancashire executives at that time have filled the void left by his departure:

  • CEO: Alex Moloney has been CEO since 2014. He was previously group CUO, and has been an employee at Lancashire since 2005.
  • CUO: Lancashire’s group CUO has been with the group and part of its underwriting team since 2007. He was CUO for its London office from 2009.
  • CFO: has been with Lancashire since 2006.

These brief descriptions should give you a sense of the stability at the top of the group.

Q3 Results

The latest quarterly results were announced on November 1st. As a result of the natural disasters mentioned above, the company has suffered a loss.

Key bullet points from these results:

  • 3% reduction in policy origination (gross premiums written) for the first nine months of 2018, and 7% reduction in risk assumed (net premiums written) over this period, too.
  • pre-tax loss of $25 million for the quarter, though pre-tax profits for the entire nine-month period were still positive at $49.6 million.

The financial ratios confirm that it was a bad quarter for the firm, but that performance year-to-date has been ok:

  • Net Loss Ratio, the ratio of claims and claim-related expenses versus premiums earned, was 77% for Q3. Anything less than 100% is a profitable insurance result. Last year, the net loss ratio for Q3 was 175% thanks to hurricanes Harvey, Irma and Maria, and earthquakes in Mexico. In case there is any doubt, I should emphasis that a net loss ratio of 175% is highly unprofitable!
  • Combined Ratio, which is the net loss ratio plus the expense ratio, was 135% for Q3. This means that after including its underwriting expenses, the company was unprofitable on an operating basis in Q3 (before taking into account any investment returns on the company’s assets).

These ratios look much better on a nine-month, year-to-date basis. On this basis, we a net loss ratio of 33% and a combined ratio of 87%, i.e. both of these numbers show good profitability on a longer timeframe. It has just been a bad quarter. That happens from time to time, when you are insuring against catastrophes!

Alex Maloney sums it up:

“The third quarter of 2018 was at least as active as 2017 in terms of the number of events to impact the industry. The magnitude of insured loss, however, has been much smaller. We have, nonetheless, produced a small loss for the quarter as a result of these events. While it’s always disappointing to lose money in any quarter, we remain in positive territory for the year to date. The loss events during the quarter are a well understood part of our business model; we are prepared for such events and they lie within our risk expectations.

Mr. Maloney provides further grounds for optimism: insurance rates are moving higher, and this includes Lancashire’s specialty lines of business. The company’s internal measures of renewal pricing shows that its specialty lines of business have seen an aggregate increase of 4% versus 2017. Pricing for its Lloyd’s of London segment is 6% higher than 2017.

Valuation

Lancashire’s share price has made little progress for the past few years, as investor returns have instead been driven by the dividend (latest share price 605p, market cap £1,207 million/$1,581 million).

Shareholders’ equity was $1,122 million at the end of September 2018, so that Lancashire trades at a premium to book value of 41% at the latest share price.

That may seem like a rich valuation, but a more favourable claims environment through 2019-2020 could do wonders for Lancashire’s earnings. On the other hand, if you think we are headed for climate chaos, this might not seem very likely!

Consensus forecasts state that Lancashire should generate net income of $140 million (FY 2019) and then $150 million (FY 2020), so that return on equity could be somewhere in the region of 12%-13% and the forward P/E multiple could be 11x (FY 2019) or 10.5x (FY 2020).

It also has a super track record of paying out earnings to shareholders in the form of special dividends, so for income hunters it could be particularly attractive. The forecast dividend yield is 6.8%, with the company’s next c. 15p special dividend having a record date this Friday (so it is ex-divi on Thursday).

And from a diversification point of view, it may also have something to offer. Hurricanes and earthquakes don’t care about the economic cycle!

On the whole, this looks like it could make for a rewarding long-term hold from current levels. As always, don’t take our word for it – make sure to do your own research!

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