Prepared by Tara, Senior Analyst at BAD BEAT Investing
The Travelers Companies, Inc. (TRV) stock has been volatile over the last year, with much of the action driven by earnings-related catalysts, and of course most recently the COVID-19 pandemic. The stock pulled back to the high $70s level a few weeks ago, a level we think is a strong buy for this name. Shares have recovered with the broader market, but we believe shares under $100 are an opportunity for long-term entry. It is not a get-rich-quick name, but it can deliver some decent returns in the short term if you time your entry. We believe that the pullback in shares is an opportunity for the long-term dividend growth investor to get long a quality company at a fair price. Consider scaling in, with buys in 10 point increments on the way down from $100 a share. This will allow a great position with a great long-term cost basis to be had. This insurer makes money hand over fist, but occasionally, it takes lumps from higher-than-anticipated catastrophe losses. We are in that situation now, with economic catastrophe not only leading to possible claims, but also from inability for individuals and companies being able to pay for premiums. This has long been a stock that we have held and is a dividend growth machine. We have done some buying, and now earnings are out. In the present column, we will discuss performance metrics that you need to be aware of.
We must watch performance
Just because this blue chip of a stock offers dividend growth and relatively stable returns over time doesn’t mean we just stop paying attention. The stock has been slammed by this virus issue. We feel it is prudent to highlight some of the critical metrics that you should be keeping an eye on.
The quarter saw a weak top line and bottom line, but in fairness, it was tough to handicap the results. Core income decreased primarily due to higher catastrophe losses, partially offset by a higher underlying underwriting gain. The improved underlying underwriting gain was adversely impacted by net charges of $86 million pre-tax ($68 million after-tax) associated with COVID-19 and related economic conditions.
The insurer continues to be incredibly profitable and frankly, the market priced the stock for much worse results in our opinion. Of course Q2, and possibly Q3 will see more pain. Catastrophe losses come and go, and so will COVID-19 pain. In the present quarter, losses were higher than expected. It is the nature of being an insurer. For every quarter with these kinds of bumps, we will have quarters that see far more or less claims than expected. Please keep that in mind. In terms of what we need to look for, like to watch for net income, core income, the customer base (net written premiums), and the underlying combined ratios. The latter two measures specifically help us gauge the health of an insurer. The COVID-19 impact is real, and will last a few quarters, but this scourge will not put a great name like TRV in jeopardy. We think you scale into the name. The name continues to be one we recommend for the long term, even if the short term is volatile, and perhaps to many, scary.
Net and core income metrics
Travelers reported net income of $600 million or $2.33 per share in Q1. This is down from last year’s $796 million or $2.99 per share. This was an expected decline year over year. When we look at the last few years, the income pattern shows that there is variability in earnings, and it stems from the unpredictable nature of claims. The company has just been hit by claims, hard, at times, but has quarters like this which we would consider a bit large for catastrophe claims. In addition, core income fell significantly, down 7.5%. Recall that core income is an operating income metric. This measure came in at $676 million or $2.62 per share, which was also down from the $755 million or $2.83 last year on this key measure. Here is the trend in core income in the last few Q1s:
Source: SEC filings, graphics by BAD BEAT Investing
Assuming catastrophe losses that were on pace with historical norms, and factoring in some pain in March, we were looking for earnings of $2.80-2.90, which factored in a 5% growth in net written premiums as well. While the results were certainly well below our expectations, it points directly at the volatility and unpredictable nature of insurance.
So, why are shares down so very much? Some of this is true earnings reduction expectations. Part of it was a panicked market. We think that 30% down is a good opportunity to start buying, but you have to scale in, acknowledging that there will be pressure in the many key metrics that we follow.
Other key metrics that you should be mindful of
It was a mixed quarter in many respects, not just on the income figures. The quarter saw a hit to the combined ratio, which was up from last year thanks to catastrophe losses and came in at 95.7%. This was above our usual target of seeing at most 95%. But it was not all bad news.
The underlying combined ratio remains strong at 91.3%, and this was down from 91.6% last year. This is among industry leaders on this important metric. Great strength exists in the commercial business and the personal auto insurance business line seems to improve meaningfully every quarter. In both the commercial and personal insurance sides of the business, net written premiums grew once again. These premiums overall were up 7.8% and 8%, respectively. As a whole, net written premiums grew 4% in the quarter. This continues a long history of growth in total net written premiums. Take a look at the growth over the last few Q1s in total revenues:
Source: SEC Filings, graphics by BAD BEAT Investing
This is an exemplary pattern and one which we feel comfortable holding on to the name, even with pain expected in the coming quarter. Look, we realize investing is about buying companies and sharing in their future earnings growth, and what we see in the earnings patterns is just within the normal variation of operating an insurance business. Sure, this is a problem. The virus is hammering most industries. While there are gains in auto and home claims given that less risk is being taken (i.e., less driving) the company is participating in a credit program to give back to loyal customers, like many other competitors. In short, the results experienced this quarter showed catastrophe hits, and missed expectations by a good 20-25 cents against most estimates. Looking forward, we urge you to continue to watch net premium growth, while monitoring the underlying and combined ratios each quarter. The pattern of premium growth is a testament to management’s successful execution of pricing and underwriting initiatives that it has implemented in recent years.
The company repurchased 3.8 million shares during the first quarter at an average price of $124.20 per share for a total cost of $471 million. Capacity remaining under the existing share repurchase authorization was $1.361 billion at the end of the quarter. Also at the end of the quarter, statutory capital and surplus was $20.808 billion, and the ratio of debt-to-capital was 20.6%. The ratio of debt-to-capital excluding after-tax net unrealized investment gains included in shareholders’ equity was 21.9%, within the company’s target range of 15% to 25%. On top of that the company raised its dividend. That is winning. The quarterly dividend was hiked to $0.85 per share, an increase of 4%.
The balance sheet is extremely strong, with its debt-to-capital ratio comfortably within management’s target range, and its holding company liquidity of $1.6 billion well above our target level and it has a very high-quality investment portfolio. We see a large drop-off in auto claims frequency saving money, but the stay-at-home auto premium credit program, offering a premium credit to customers for April and May, will offset that. At the same time, there may be some offsetting impact in terms of auto severity in terms of claim levels.
Looking at premium volume for the remainder of the year, we expect to see more significant impacts in the economic contraction on written premium and earned premium. And because earned premium typically lags written premium, this may be felt beyond Q2 and Q3. How much and for how long will depend on the extent and duration of the negative economic impacts related to the pandemic. Management has not provided forward-looking information about pricing levels or underlying underwriting margins, given the increased level of uncertainty in the current environment. This brings into question where revenues will go.
On the top line, we are anticipating net written premium revenues of $28-30 billion. This would be some contraction, which is more than priced in. This accounts for our assumption that written premiums will be continuing to grow volume-wise but premium charges may be lower. Assuming there are elevated claims for the entire year from COVID-19, in conjunction with pain in revenues overall, we think that a higher combined ratio is likely, and a hit to earnings will occur. We are anticipating (a wide) earnings per share of $8.75-10.50 in 2020.
At the lowest end, which would be a big contraction, this drives the FWD price to earnings to 11.4 at $100. If we assume you are able to buy in 3 levels at $100, $90, and $80 over the next few months in a progressively larger fashion, your cost basis could be $87.50, or lower, which would be <10X FWD EPS. This would be an exceptional price for this 4% dividend payer.
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Disclosure: I am/we are long TRV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.