There’s a lot to like about Dow-30 component The Travelers Companies (TRV – Free Travelers Stock Report). With its solid fundamentals and strong position in the property/casualty (P/C) insurance industry, TRV’s placement among the elite group of stocks is surely well-deserved. Although the blue chip seems set to take a breather, following record-level results registered last year, it may be worth keeping on the radar for those with specific investment objectives.
No doubt, conditions in the property/casualty insurance industry look a lot better these days than they did after Hurricane Sandy slammed into the northeastern part of the United States in late 2012, leaving behind widespread devastation and billions of dollars-worth of property damage, not to mention the loss of life. While many P/C insurers were severely hurt by the catastrophe, Travelers managed to emerge relatively unscathed, despite incurring Sandy related losses in 2012’s final quarter. Since then, TRV’s operating performance has not failed to impress. Milder storm seasons, along with a high-quality book of business amid a very favorable pricing environment, have benefited this insurance heavyweight immensely. And Wall Street has certainly taken notice, as evidenced by the rising stock price in the Graph section of the Value Line page.
To begin with, we point out that Premiums Earned, found in the Statistical Array in the center and in the Quarterly Earnings box on the lower left-hand side, seem poised to rise further. The number refers to the amount of money (or “premiums”) an insurer receives from policyholders as compensation for the risk it assumes, and is influenced by such factors as rate increases. Here, the anticipated increases reflect generally positive pricing trends across the industry, post Sandy. But, as our estimates indicate in the Array and in the Quarterly Earnings box, the bottom line is due for a retreat this year, with gradual advances probable thereafter. Indeed, this brings us to examine some of the most significant figures for an insurer, all expressed as a percentage in the Array. The Underwriting Margin, commonly referred to as the “combined ratio” and derived by the difference between 100% and the sum of the loss and expense ratios, is a key metric that gauges the profitability of a company’s core insurance operations. Losses on claims filed and major catastrophes, together with an insurer’s risk exposure, as well as policy writing/actuarial and other administrative expenses, are the chief aspects that influence the combined ratio. A general rule of thumb is the bigger a positive underwriting margin, the better.
Admittedly, the rate environment may soften a bit with time. What’s more, weather patterns, which are difficult to forecast, add a degree of uncertainty. Given the quiet storm seasons of late, the likelihood that this can change is greater now. In the case of Travelers, year-over-year comparisons are tough, versus the hard-to-beat results of 2014, so a slight deterioration of the underwriting margin wouldn’t be a surprise. The sentiment is echoed in the Commentary section of the report by analyst Alan G. House, where he states that “last year’s solid loss ratio will be difficult to match”. He goes on to explain that “the recent pattern of tame weather might reverse course” and that “we expect the combined ratio to trend higher in 2015”.
Other important elements to consider are Investment Income per share and Investment Income/Total Investments, both displayed in the Array, which tell how well an insurer’s investment portfolio pays off. Given that most of TRV’s holdings are fixed-rate securities (bonds) and interest rates have been low, returns have been rather uninspiring in recent years, although that should improve if the Federal Reserve raises rates later this year. Meanwhile, Price-to-Book Value (or the stock price against the value of the insurer’s assets) is another essential factor, often used as a guide in deciding whether or not to invest in an insurance equity. A percentage below 100% means the stock is undervalued, whereas a figure above 100% implies that the issue is overvalued. Based on the steady price climb over the past few years, TRV is currently a bit overvalued.
From an investment perspective, Travelers has allure. True, the Dow member is no longer a standout for Timeliness (or year-ahead relative price performance); note that the rank shown in the Ranks section has slipped a notch to 3, Average, since the full-page report was published on March 13th. However, the Projections box just underneath suggests the three- to five-year capital gains potential is decent at the recent price level shown at the top of the report. In addition, though not extraordinary, the dividend yield (Top Label) and estimated long-term growth of the payout (Annual Rates) look reasonable for this insurance industry stalwart.
In the meantime, the issue boasts a superior risk profile, with a Safety rank (Ranks box) of 1, Highest, which indicates TRV is among the least risky selections in our Survey. That’s supported by an exceptional mark of A++ for Financial Strength, reflecting healthy finances, while outstanding scores for Price Stability and Price Growth Persistence add even more appeal. These measures are located in the Ratings section at the lower right-hand corner. Summing it all up, we think there are plenty of incentives here for conservative, income-minded types to include this blue chip in a diversified portfolio, preferably on a share-price pullback. On a risk-adjusted basis, the three- to five-year total return prospects (or price appreciation plus dividend hikes) are, indeed, attractive.