Price – $37.18 Market Cap – $78 million
Net Cash & Investments on B/S – $35.70
2011 EPS estimate = $3.10
2012 Dividend - $0.28
Our Margin of Safety
A $78 million company which is has a moat around its business, remains profitable and yet has “excess” cash and investments of at least $75 million which could potentially be taken out of the business without affecting operations or loss reserves. Essentially we are buying a low risk investment portfolio and getting a profitable family-run business for free.
Buying on a low multiple of trough cyclical earnings a company that has demonstrated its resilience across many real estate cycles.
Customers are legally obliged to buy their product.
Investors Title Company was founded in 1972 by current chairman, CEO and patriarch J. Allen Fine. He has grown the business from nothing to a $80-100 million business. Allen Fine earned a bachelor's degree in accounting and master's in business administration from the University of North Carolina at Chapel Hill. He is a CPA and began his career teaching accounting at UNC-CH School of Business. In the late 1960s, Allen made the decision to start a business. He identified the need for title insurance, researched the subject, and in 1972 Investors Title first opened its doors.
Two of his sons, one a qualified CPA and one a CFA, are now also in the business as CFO and as company secretary respectively. Between the family and other senior execs they own 26% of the common stock.
ITIC isn’t just the Fine family business in that it puts food on the table; this business is the family legacy in the state of North Carolina. It would seem that they really play on the fact that this is more important to them than just insurance. If so, that’s a good intangible to be invested alongside. Highly specialized, passionate owner operators.
Traditionally a North Carolina based business, the company is expanding aggressively into other states, particularly Texas, which has gone from a negligible amount to 37% of revenue in the space of a year!
The Business Model
As I said above, customers are legally obliged to buy ITIC’s product. Let me explain. A purchaser of real estate buys title insurance to eliminate their risk of loss due to title defects, encumberances or liens against their property. In fact, mortgage lenders require title insurance before lending — to protect them from having security over bad assets.
Title insurance protects owners and lenders from myriad potential issues after the completion of a real estate purchase including forgeries, tax judgements and incorrectly executed deeds. Such defects could call into question whether the buyer has clear title to the property. Title insurers are responsible for performing an examination of the land records to ensure that the seller has proper standing to convey ownership to the buyer. In the event that the title proves to be defective at a later date, the title insurer is responsible for covering the resulting losses up to the coverage limit of the policy.
Issues of some sort arise in one in three residential transactions. The job of the title insurer is slightly different to a normal insurer in that they endeavor to head off these problems before they arise.
Traditional insurance takes a premium, has a small SG&A expense and a very large reserve against claim losses. Title insurance takes a premium, spends a lot on SG&A expense as it investigates and frees the property from potential problems and liabilities — the loss reserve is comparatively small. By far the main expense in the industry is the due diligence and investigation required to make sure titles are free and clear, this constitutes 70-80% of each premium received or 70-80% of revenue whichever way you want to look at it.
Title insurance is not normal insurance. Insurers seek to assume risk and be compensated for doing so; title insurers look to identify risk and then eliminate it before guaranteeing against their own work. It is a service business, they only compensate if they don’t do their job properly.
Title insurance seems to be a pretty closed industry with no major competitors entering in the last few years. The business is a transactional one built on relationships between people. There is no price competition between companies as the price is set by the state. Buyers usually take advice from their professional service providers on whom to buy title insurance from. So the realtors and lawyers can allocate business on the basis of whom they have a good relationship with; the Fines at ITIC have been around for 40 years, are local specialists and have had as long as anyone to build up a good network of referrers in their business.
Home or Branch Policies
Title insurance companies typically issue their policies directly through branch offices or through title agencies. In the company's home and branch operations, the company issues the insurance policy and retains the entire premium, as no commissions are paid in connection with these policies. All of the Company's branch offices are located in North Carolina; as a result, the home and branch office premiums written are primarily for North Carolina policies.
When a policy is written through a title agency, agents retain the majority of the title premium collected, with the balance remitted to the title underwriter for bearing the risk of loss in the event that a claim is made under the title insurance policy. The increase in the percentage of total premiums written by agencies in 2011 is primarily due to the Company's strategy of growth through expansion of its agency base and the influence of local geographic trends. Agency premiums have become 80% of the business, up from 70% just 12 months ago as they achieve scale outside of North Carolina.
The Size of the Addressable Market
ITIC is a tiny player in the broader American title insurance market. There are four national insurers that make up 90% of business written nationally. ITIC has a national market share of only 0.6% due to its traditional, specific focus in North Carolina where they now do around a third of their business and which historically was the source of almost all of their revenue.
Within North Carolina however, ITIC is one of the Big Players commanding around a quarter of the market, a share which has held steady for the last decade.
The Total Title Insurance market in the U.S. was worth about $3.5-4 billion per annum in the early 1990s, and north of $16billion as of the mid 2000s. In 2010 it was $9.6 billion, it doesn’t seem unreasonable to imagine that this might tick back up as the real estate market becomes more liquid again.
It is worth noting that ITIC is primarily dependent on real estate volume not pricing. To be an owner of ITIC one doesn’t have to have a rosy outlook on house prices, merely a belief that at some stage there will be increased activity and when there is the delta to ITIC’s profits will be large. The re-financing market (because it involves new mortgage docs) is also an important part of ITIC’s market, given that rates have been ultra low for three years now it’s likely that anyone who could refinance, has refinanced.
From the recent management statement;
In 2010, refinancing activity accounted for 69.9% of all mortgage originations. In 2011, refinancing transactions are projected by the Oct. 11, 2011 MBA Mortgage Finance Forecast to account for 66.2% of mortgage originations. The projected decrease is attributable to the higher levels of refinance volume that occurred in prior years, as well as reduced available equity and more stringent requirements being imposed by lenders. Despite current mortgage rates falling to the lowest levels in decades, the Company believes that many homeowners would need rates to fall even further to justify the closing costs involved with subsequent refinance transactions.
The point being, I really think we are looking at trough revenue for the industry and for the company. Despite this, it’s a reasonable 12x earnings.
Positive Business Mix
In the third quarter of 2010, ITIC began writing business in Texas, the second largest title insurance market in the U.S. This has already had a positive impact on premium growth.
North Carolina is decreasing as a share of the overall business as it expands into other states. NC premiums are less than half the national average and therefore the resulting loss ratio is always higher for NC than for other states, all other things being equal. This should help to improve margins if they can achieve operational scale in alternate, higher premium states.
From the annual report:
In a cyclical industry such as ours expense management and operating efficiency are critical. We remain focused on managing expenses with an emphasis on staffing and occupancy costs. In 2010, payroll and occupancy costs decreased by 4% YoY even as we continued to make targeted investments in growth opportunities and strategic technology initiatives.
Remarkably, the company spent the same on SG&A in 2003 as in 2010 despite the fact that it wrote 38% more business in 2003. This demonstrates that it is a relatively high fixed cost business as they are reluctant to cut staff because staff own relationships which are the source of business. This provides a great deal of built in operating leverage which is currently slack but is there, waiting to enhance the bottom line.
Because of the size of their investment portfolio relative to the market cap ($83.6 million Fixed Income portfolio) there is a great deal of sensitivity to interest rates. The vast majority of the portfolio is in Treasuries, Muni securities and corporate bonds. Unfortunately, I cannot ascertain the duration of the portfolio beyond a vague statement in the accounts that the “effective maturity of the majority of the bonds is within 10 years.”
Although they clearly bear interest risk and the capital value of the bond portfolio may change due to rising interest rates, it is worth noting that for each 1% rise in interest rates, net income would likely increase by something near $1 million on a portfolio of that size.
"For the nine months ended September 30, 2011, net premiums written increased 50.1% to $63,303,202, investment income decreased 3.3% to $2,665,245, total revenues increased 42.3% to $69,858,103 and net income increased 26.2% to $5,054,477, all compared with the same nine month period in 2010.
Both net income per basic and diluted common share increased from $1.75 for the nine months ended September 30, 2010 to $2.34 and $2.32, respectively, for the comparable period in 2011."
Get The Business For Free?
ITIC is a nice story and a good business, but it’s not one I can get hugely excited about. However, if you offer it to me for free, I’ll take it. I think you can get the business for free because, as it is currently, ITIC is vastly overcapitalized. Thankfully, it has a very clean balance sheet which makes it easy to identify the value — being conservative:
|Investments in Fixed Income||$83.6m|
|Investments in Equities||$17.7m|
|Short Term Investments||$21.7m|
|Cash and Cash Equivalents||$14.7m|
|Property (at book cost)||$3.6m|
|Reserves for Claims||$37.6m|
|Shareholder Equity =||$92.6m|
This is remarkable relative to a market cap of $78 million! On top of this the company had net income of about $5.4 million over the last 12 months.
The company could close down today, pay off all liabilities, liquidate their portfolio and return $92.6 million/2.12 million shares = $43.67 per share to its owners. That’s a 17% premium to today’s price, but it would be madness to shutdown a stable, profitable and growing business — it’s just nice to know!
The value of the real estate seems to be substantially understated too as demonstrated in this article:
This adds another $5-8 million to book value depending on how conservative or optimistic you would like to be. Significant, as it adds a few dollars to the intrinsic value of the share.
“The Company purchased 168,516 shares in the first nine months of 2011 and 10,592 for the same period in 2010 at an average per share price of $32.20 and $31.22, respectively.”
There is authority to buy back up to 500,000 shares under the current scheme. The recent purchases shrunk the share count by an impressive 7% indicating management see some serious value and that they are willing to do something about it.
Of course with most equity investments the risk is that the future doesn’t look like the past. In particular to ITIC, the risk that is likely weighing most heavily on the market is the prospect of years of continued depression in housing. A sustained slump would result in low transaction volumes as “underwater” borrowers are unable to sell their houses without wiping out their equity, and new construction continues to flat-line the bottom with low levels of housing starts. ITIC has a geographic concentration that does not include the bubble markets of California, Florida, Nevada and Arizona and is therefore protected from the worst regions. Additionally, the company has proven its resiliency and profits in periods of exceptional stress, with the exception of 2008.
Unfortunately, I can’t see a special dividend in the near future but it’s likely that the management will continue to buy back undervalued shares. At the current market cap of $78 million you get an owner-operated business of long standing and good reputation with $6 million of cyclically depressed earnings and a liquidation value of around $100 million.
Running this operation you have an experienced and highly incentivized management team with a multi-decade track record expanding the business into new higher margin territories. It’s a rare opportunity when a consistently profitable business is available for free. The only reason the stock is this cheap is because it’s unknown, something this article is designed to remedy.