HRTG - am I missing something?

One of my smallish positions is in an insurance company called Heritage Insurance. Did I mention they sell insurance? Property and casualty insurance in Florida.

They’ve been growing like a weed. In 2015 full year sales grew 69% YoY, and EPS grew 67%. Yet they’ve been sporting a PE of only 7 or 8 all year. Here are the details:

Last 8 quarters Revenue:

$44M
$47M
$58M
$85M
$105M
$99M
$89M
$101M

Last 8 quarters EPS:

$0.42
$0.39
$0.33
$0.66
$1.00
$0.84
$0.55
$0.67

YPEG is 0.07. Yep.

In the Q4 conference call, they announced that they are having a tough Q1 2016 weather-wise, and the stock sold off…eventually about 20-25%. Down to a PE of 5. F-I-V-E. I can’t find any guidance, but in the call they discussed how bad the loss is going to be. Pretty heavy insurance-speak, so I’d be grateful if anyone can translate, or if they have given guidance somewhere and I just haven’t found it, PLEASE let me know! But anyway, the analysts seem to think EPS will only be about half as much as last year this quarter, although they’ll end up close to even for 2016 as a whole. The company seems to think the full year could be even better than that, although again I’m not sure they said that directly.

Anyway, I know this company can’t grow 70% every year, but they are growing. Analysts seem to think sales will grow around 15% – but I’d love to know what they expected in 2015. I’m guessing not 70%.

I just can’t understand the PE of 5. I understand that Q1 is going to be disappointing, but it just seems like the company is priced for a disaster. Why had PE been running at 7 anyway? Is it just that insuring property in Florida is inherently risky? I feel like the company has their ducks in a row. Sure they will have ups and downs, but they are prepared for bad weather in Florida. It’s literally what they do.

A company growing like this with a PE of 5 baffles me. No matter what business they’re in. Can someone help me understand?

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One of my smallish positions is in an insurance company called Heritage Insurance. Did I mention they sell insurance? Property and casualty insurance in Florida. They’ve been growing like a weed. In 2015 full year sales grew 69% YoY, and EPS grew 67%. Yet they’ve been sporting a PE of only 7 or 8 all year.

Hi Paul, It sounds very interesting! I wish I knew something about insurance companies, and the risks therein, so that I could look into it, but I’d be pleased to learn about it if someone on the board has that kind of expertise.

I guess I could start with a couple of questions. Why are they growing so fast? Are they growing at 69% because they are taking properties that no one else will insure? Are they taking on a lot of risky property in danger from hurricanes and high water? (This is Florida after all). Is that why they are having a lot of weather related losses this quarter? (I’m NOT assuming that that is the case. I’m just throwing it out to get the discussion started.)

Best,

Saul

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Why are they growing so fast? Are they growing at 69% because they are taking properties that no one else will insure? Are they taking on a lot of risky property in danger from hurricanes and high water? (This is Florida after all).

http://seekingalpha.com/article/3280525-how-to-find-a-great-…

This article is almost a year old, but still relevant, especially toward the end about Citizens, the state-sponsored reinsurance, and the potential risks. I don’t know how to weigh these risks, but given:

  1. The stock is super cheap on a PE and YPEG basis
  2. Mr Market hates risk

…I feel that this could be a big opportunity. Like Saul said, I would love for someone who knows more about insurance to weigh in.

Is that why they are having a lot of weather related losses this quarter?

There’s a lot to glean from the conference call about Q1 and reinsurance in general. I’m still wading through (pun?) but have a look:

http://investors.heritagepci.com/~/media/Files/H/Heritage-IR…

(cool that they provide a transcript)

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Paul

Are your earnings numbers GAAP or non-GAAP?

Cham

GAAP. I see no mention of non-GAAP numbers on their financials, or anywhere else.

That article you linked to was a wonderful example of how to evaluate an insurance company, using Heritage as a random example. It says it all:

Quick background: one state owned company, Citizen’s, had way too large of a market share of the P&C contracts in Florida and the legislature believed this posed a systemic risk if a large hurricane came through and decimated the state. About 20 years ago Citizens started selling off (“depopulating”) some contracts to private insurance companies. As an incentive for new companies to come in and buy up these contracts Citizens and the state of Florida will reinsure a portion of the contracts for three years. Now these contracts may be profitable with the free reinsurance, but after three years, the initial reinsurance goes away and the companies which bought these contracts realize the premiums don’t cover the risk. To counteract that, many companies raise the premiums on these policies, which forces the policyholders to cancel policies. Initially, these premiums are extremely profitable for companies, which is why Heritage’s combined ratio looks so good.

That combined with no hurricanes making landfall in the three years Heritage has been a company, has been extremely lucrative. However, these good times will not continue forever and eventually reinsurance costs will rise and the company won’t be able to grow as fast because the Citizens depopulation is nearing completion. So eventually margins will shrink and growth will slow. In fact, several companies buying these policies have failed recently even without a hurricane reaching mainland Florida. Will the experienced management team be able to navigate the market? This is a risky business Heritage is in and this fact negates a few of the passes Heritage earned.

It is important to do a lot of digging to find out what these qualitative issues every insurance companies have. You can’t always rely on the quantitative numbers to get the whole picture. Is this more work? Sure, but you have to dig deeper than everyone else if you want to earn outsized returns. If you don’t put in the extra work you may think this stock was the greatest ever, but after digging deeper you find this company is in an extremely risky sector of the P&C market and should carry a risk premium. Heritage may be trading at low PE for a reason. Initially Heritage passed 3 of the 6 tests, but future profitability should be questioned. I would rate Heritage a hold at best currently.

It’s really a brilliant article Paul. Thanks for linking to it. You have your answer right there. I personally wouldn’t touch it. One really big hurricane and they could be out of business, not just showing slower growth.

Best,

Saul

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One really big hurricane and they could be out of business, not just showing slower growth.

Thanks, Saul. Very interesting to me that you would avoid this company altogether. I guess it’s also interesting to me to consider what the risks are. I ran it by my friend who’s an actuary at an insurance company. Here’s his quick take:

They shouldn’t go under from hurricanes because of their reinsurance coverage. They mentioned it a lot in the quarterly call, but didn’t say much specific, e.g. rates, retention limits. But I get the sense they have that under control.

I really like the sound of that commercial residential block of business. Contributes about 20% of their premium and has a 5% loss ratio. That’s obviously really profitable.

Expense ratios in the 20-25% range are pretty good.

I wanted to check their (Net) Premium to Surplus ratio, but only saw Gross numbers. The ratio should be like 2:1, or less ideally. Higher ratios would suggest they’re more susceptible to being hurt by large claim spikes, since it would mean they’re stretching their resources to write a lot of premium. Would be easy if you can find actual financials to go with the transcript.

“the guidance we have given in the past of an expected combined ratio on a gross basis of 85% in years which we have no hurricanes.”

So that’s the complement of the answer you want. Maybe you can find if they’ve given guidance about hurricane years in the past. Just a complete guess, I’d expect something more like 110-120% range. Just really depends how they’ve structured their reinsurance, which I’m not sure is available information. Maybe Arash will ask that next time. He asked them every other damn thing lol.

They shouldn’t go under from hurricanes because of their reinsurance coverage.

Not going under is a Good Thing, but there can be quite a distance between that and prospering.

Not going under is a Good Thing, but there can be quite a distance between that and prospering.

Agreed. A second email from my buddy confirmed that they would almost definitely show a net loss in a hurricane year, although his 110-120% combined ratio threshold was just a guess.

Here’s his bottom line:

Frankly my first reaction was no way I would get involved with a company like that in FL. Their numbers look good enough to override it, but the hurricane danger is exactly why that caution was there by default. They print money until they don’t, basically.

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