Picking turnaround candidates is a tricky business; a sufficient margin of safety must be present or the practice becomes more akin to speculation rather than investing. All that said, turnarounds represent a chance at multibaggers if one can successfully identify a company which is about to increase its profitability. Earnings surprises or sudden returns to profitability frequently provide a powerful catalyst for a stock, particularly if the stock is small and possesses a limited float.
I believe that a favorable set of circumstances has unfolded for tiny Florida-based insurer 21st Century Holdings (TCHC, Financial) which is likely to return to profitability in the upcoming quarter and upcoming years. The circumstances are a result of new legislation which is favorable towards Florida insurers, rate increases on premiums, and discounts in the companies' reinsurance costs which are largely a function of an increased underwriting discipline.
Company Description
21st Century Holdings (TCHC) is a multiple line insurer which operates in Florida. Over 80% of the companies' revenues are derived from Property and Casualty insurance. The company has recently diversified its P&C insurance coverage area but still remains highly concentrated in the tri-county area surrounding Miami. Slightly under 40% of its P&C premiums are written in that area. The heavy concentration of policies written in the same zone represents the main risk for investors.
Financial Strength
TCHC has a tangible book value of $7.05 a share, which translates to about one-third of its tangible equity. Despite the company's industry-low P/B ratio, the stock has been dismissed due to the fact it has a string of unprofitable quarters which dates back three years. Further exasperating shareholders is the fact that competitors such as UVE have turned steady profits for five straight years while TCHC has been floundering. The result has been a steady sell-off of the TCHC shares which rekindles with each disappointing quarter. The stock is now trading near its lowest point since the spring of 2009.
From a balance sheet perspective, TCHC is quite strong. The company has a bond and equity portfolio worth around $130 million in addition to cash and short-term securities of around $22 million; tangible book value was slightly over $56 million at the end of the last quarter. Bear in mind that the market capitalization for the company is only about $19 million.
The key capital ratio for an insurance company is its tangible equity to total asset ratio (TE/TA). This capital ratio for TCHC is just a hair under .3 which is quite conservative in the P&C business. Incidentally, that is almost the identical capital ratio as P&C blue-blood Chubb (CB, Financial). Analysts like to see the ratio at a minimum of .2. By comparison, rival Florida insurer UVE maintains a TE/TA ratio of slightly under .18.
The strong capital ratio suggests that TCHC is currently overcapitalized and capable of writing additional business without reducing its balance sheet margin of safety. The management explains that the company is now only writing business which is operationally favorable, insisting upon more rigorous underwriting standards.
Further, they have opted not to renew a number of policies which did not meet the more stringent standards, including a number of policies in which they had already purchased reinsurance. For certain policies, the company is not receiving premiums although they are still paying for reinsurance. Such policies will soon be eliminated which should result in a slight improvement in operational efficiency.
The maximum net premiums written (premiums less reinsurance written) to capital ratio for the insurance industry is generally two times a company's equity. In other words, the maximum amount of net premiums which TCHC could write would be in the neighborhood of $112 million. In the last three years the company has averaged less than $50 million per year in net premiums largely due to undisciplined underwriting standards which resulted in exorbitant reinsurance costs. It would seem those problems are being rectified in light of the reduced reinsurance costs; that should allow the company to increase net premiums in the current and upcoming years.
Operational Improvements and Return to Profitability
The contention that the underwriting discipline for TCHC has increased significantly is supported by an improved loss ratio of 67% in the recent quarter. The P&C operating ratio has improved to around 60% in the first six months of 2011; however, the overall ratio has been hampered by extremely high costs in the company's automotive insurance sector. As of July 1 of the current year the company started recognizing a 16% savings in P&C reinsurance costs. That figure represents around $600 thousand per month in cost savings. That translates to a savings of $1.8 million per quarter looking forward.
In the first quarter of the calendar year, the company merged two subsidiaries which has resulted in a decrease of operational expenses of about 14 percent. Additionally, Florida has approved a rate increase of 13.9% for all policies assumed through its state-run, Citizens Property Insurance Corporation, effective August 21, 2011. This amount follows an increase of 15% which took effect on July 1st, 2010. TCHC assumed policies from the corporation in 2009.
Barring a large increase in claims in the current quarter or a significant decrease in the investment income for the insurer, TCHC appears set to record a small profit in the current fiscal quarter which ends on October 31.
Changes in Florida Law
Earlier this year Florida enacted a number of legislative changes which were favorable toward P&C companies. Specifically, restrictions on sink hole losses were placed in effect, statues of limitations on sink hole claims (two years), and wind/hurricane claims (three years) were enacted. Full insurance payouts will now become subject to the completion of repairs and final payments will be made to contractors rather than homeowners. Additionally, rate increases were approved for companies which assumed policies which were previously written by the State.
The most significant changes for TCHC involved the statute of limitations on hurricane claims and the rate increases enacted for assumed Citizens policies. The state is moving toward privatizing high-risk areas, although Citizens still writes policies for about 1.3 million customers in high-risk areas.
Recap
1) TCHC represents a turnaround candidate with a margin of safety in the form its industry low price to tangible book ratio.
2) Operational improvements and increased underwriting discipline has put the company on the verge of profitability for the first time in three years.
3) Recently enacted legislation, increased rates and decreased reinsurance costs should materially improve the operating results of TCHC looking forward.
4) TCHC is an asset-based play with a potential catalyst in the form of a return to profitability.
Disclosure: Long TCHC
I believe that a favorable set of circumstances has unfolded for tiny Florida-based insurer 21st Century Holdings (TCHC, Financial) which is likely to return to profitability in the upcoming quarter and upcoming years. The circumstances are a result of new legislation which is favorable towards Florida insurers, rate increases on premiums, and discounts in the companies' reinsurance costs which are largely a function of an increased underwriting discipline.
Company Description
21st Century Holdings (TCHC) is a multiple line insurer which operates in Florida. Over 80% of the companies' revenues are derived from Property and Casualty insurance. The company has recently diversified its P&C insurance coverage area but still remains highly concentrated in the tri-county area surrounding Miami. Slightly under 40% of its P&C premiums are written in that area. The heavy concentration of policies written in the same zone represents the main risk for investors.
Financial Strength
TCHC has a tangible book value of $7.05 a share, which translates to about one-third of its tangible equity. Despite the company's industry-low P/B ratio, the stock has been dismissed due to the fact it has a string of unprofitable quarters which dates back three years. Further exasperating shareholders is the fact that competitors such as UVE have turned steady profits for five straight years while TCHC has been floundering. The result has been a steady sell-off of the TCHC shares which rekindles with each disappointing quarter. The stock is now trading near its lowest point since the spring of 2009.
From a balance sheet perspective, TCHC is quite strong. The company has a bond and equity portfolio worth around $130 million in addition to cash and short-term securities of around $22 million; tangible book value was slightly over $56 million at the end of the last quarter. Bear in mind that the market capitalization for the company is only about $19 million.
The key capital ratio for an insurance company is its tangible equity to total asset ratio (TE/TA). This capital ratio for TCHC is just a hair under .3 which is quite conservative in the P&C business. Incidentally, that is almost the identical capital ratio as P&C blue-blood Chubb (CB, Financial). Analysts like to see the ratio at a minimum of .2. By comparison, rival Florida insurer UVE maintains a TE/TA ratio of slightly under .18.
The strong capital ratio suggests that TCHC is currently overcapitalized and capable of writing additional business without reducing its balance sheet margin of safety. The management explains that the company is now only writing business which is operationally favorable, insisting upon more rigorous underwriting standards.
Further, they have opted not to renew a number of policies which did not meet the more stringent standards, including a number of policies in which they had already purchased reinsurance. For certain policies, the company is not receiving premiums although they are still paying for reinsurance. Such policies will soon be eliminated which should result in a slight improvement in operational efficiency.
The maximum net premiums written (premiums less reinsurance written) to capital ratio for the insurance industry is generally two times a company's equity. In other words, the maximum amount of net premiums which TCHC could write would be in the neighborhood of $112 million. In the last three years the company has averaged less than $50 million per year in net premiums largely due to undisciplined underwriting standards which resulted in exorbitant reinsurance costs. It would seem those problems are being rectified in light of the reduced reinsurance costs; that should allow the company to increase net premiums in the current and upcoming years.
Operational Improvements and Return to Profitability
The contention that the underwriting discipline for TCHC has increased significantly is supported by an improved loss ratio of 67% in the recent quarter. The P&C operating ratio has improved to around 60% in the first six months of 2011; however, the overall ratio has been hampered by extremely high costs in the company's automotive insurance sector. As of July 1 of the current year the company started recognizing a 16% savings in P&C reinsurance costs. That figure represents around $600 thousand per month in cost savings. That translates to a savings of $1.8 million per quarter looking forward.
In the first quarter of the calendar year, the company merged two subsidiaries which has resulted in a decrease of operational expenses of about 14 percent. Additionally, Florida has approved a rate increase of 13.9% for all policies assumed through its state-run, Citizens Property Insurance Corporation, effective August 21, 2011. This amount follows an increase of 15% which took effect on July 1st, 2010. TCHC assumed policies from the corporation in 2009.
Barring a large increase in claims in the current quarter or a significant decrease in the investment income for the insurer, TCHC appears set to record a small profit in the current fiscal quarter which ends on October 31.
Changes in Florida Law
Earlier this year Florida enacted a number of legislative changes which were favorable toward P&C companies. Specifically, restrictions on sink hole losses were placed in effect, statues of limitations on sink hole claims (two years), and wind/hurricane claims (three years) were enacted. Full insurance payouts will now become subject to the completion of repairs and final payments will be made to contractors rather than homeowners. Additionally, rate increases were approved for companies which assumed policies which were previously written by the State.
The most significant changes for TCHC involved the statute of limitations on hurricane claims and the rate increases enacted for assumed Citizens policies. The state is moving toward privatizing high-risk areas, although Citizens still writes policies for about 1.3 million customers in high-risk areas.
Recap
1) TCHC represents a turnaround candidate with a margin of safety in the form its industry low price to tangible book ratio.
2) Operational improvements and increased underwriting discipline has put the company on the verge of profitability for the first time in three years.
3) Recently enacted legislation, increased rates and decreased reinsurance costs should materially improve the operating results of TCHC looking forward.
4) TCHC is an asset-based play with a potential catalyst in the form of a return to profitability.
Disclosure: Long TCHC
