(Published by Bob Ciura on June 16)
2017 has been a terrible year so far for AmTrust Financial Services Inc. (AFSI, Financial).
First, it restated five years’ worth of earnings, reducing profits earned in that time by $310 million.
If that were not bad enough, things got even worse just one week later.
An article in The Wall Street Journal said secret recordings were used in conjunction with an SEC inquiry into the company for questionable accounting practices.
AmTrust issued a response, insisting its books are clean, but the damage has been done. The stock has lost nearly half its value year to date.
On the surface, AmTrust appears to be an attractive dividend stock. It is one of 416 stocks with a 5%-plus dividend yield.
You can see the full list of established 5%-plus yielding stocks here.
It is also a Dividend Achiever, a group of 264 stocks with at least 10 years of consecutive dividend increases.
You can see the entire list of 264 Dividend Achievers here.
While there is a great deal of headline risk hanging over the company right now, it could be a bargain if the SEC issues are much ado about nothing.
Business overview
AmTrust is a property and casualty insurer. It operates in the following business segments:
- Small Commercial Business (40% of 2016 revenue).
- Specialty Risk and Extended Warranty (28% of 2016 revenue).
- Specialty Program (17% of 2016 revenue).
- Service and Fee Income (10% of 2016 revenue).
- Investment Income (5% of 2016 revenue).
The company’s primary insurance products are workers’ compensation, commercial auto and property coverage and warranty insurance.
AmTrust went public in 2006. In the 11 years since, it has grown into a company with 125 offices in 70 countries, writing almost $8 billion in annual premiums.
It generated 81% of 2016 gross written premiums in the U.S. last year, but it is expanding its geographic diversification. The company sees growth potential in Europe and Southeast Asia.
AmTrust’s commercial business is its most important segment.
Source: April 2017 Investor Presentation, page 18
The negative headlines have taken a steep toll on AmTrust’s share price. The stock has lost nearly half of its value since the beginning of 2017.
Still, the company remained highly profitable last year and has a long track record of growth.
Insurance is a very strong business because insurers make money in two ways.
First, they bring in revenue from policy premiums. They also make money by investing the large sums of accumulated premiums not distributed as claims, known as float.
These two revenue streams are why insurance companies can create substantial shareholder wealth over long periods of time.
AmTrust is no exception.
Growth prospects
From 2006 to 2016, AmTrust’s book value per share increased by 19.4% on average each year.
According to the company, gross written premiums have increased from $526 million in 2006 to $7.95 billion in 2016. In that time, premiums have grown by 31% each year on average.
Much of this growth is due to the company’s aggressive acquisition strategy. Since its founding in 1998, AmTrust has acquired more than 40 companies.
Over the past 10 years, AmTrust has increased its book value by over 500%.
Source: April 2017 Investor Presentation, page 4
Investment income has played a key role in this growth. From 2011 to 2016, investment income has grown at a 30% annual rate.
While news of an SEC investigation casts a dark cloud over the stock price, the company’s fundamentals have held up relatively well.
Diluted earnings per share declined 12% in 2016.
Operating earnings declined a more modest 10%. Operating earnings exclude non-cash items such as realized investment gains or losses, goodwill impairments, losses on extinguishment of debt and foreign currency translations.
The declines were due to a reserve charge of $65 million, or approximately 24 cents per share, resulting from higher loss adjustment reserves in the Specialty Program segment.
Still, AmTrust remains highly profitable. 2016 operating EPS of $2.64 more than cover the company’s dividend.
Moreover, AmTrust held a net combined ratio of 93.7% in 2016.
Source: April 2017 Investor Presentation, page 6
The combined ratio is calculated by adding incurred losses and expenses and dividing by premiums earned.
A combined ratio below 100% indicates a company’s underwriting is profitable.
Conditions have improved to start 2017. Net earned premiums rose 14% in the first quarter. Total revenue increased 14% as well.
Operating EPS fell 54% in the first quarter, however.
Nearly one-third of the earnings decline was due to higher catastrophe losses due to higher wind and hail damage in the Small Commercial Business segment.
In addition, earnings were weighed down by higher professional service fees of approximately $17 million and a higher effective tax rate.
Dividend analysis
The big test for AmTrust is whether it can stem the decline in earnings per share.
To be sure, many of the factors behind last quarter’s earnings decline are cyclical, such as adverse weather conditions.
AmTrust’s earnings are also weighed down by the higher level of spending for the company to right the ship after the SEC issue. For example, the company switched its auditor to a Big Four accounting firm.
Additionally, AmTrust has taken steps to strengthen its balance sheet. It recently sold its 10.58 million shares of National General Holdings (NGHC, Financial) for proceeds of $211.7 million.
Raising cash can help support the dividend until the fundamentals recover.
AmTrust has a quarterly dividend rate of 17 cents per share. Annualized, this works out to 68 cents per share.
In addition to its high yield, the company grows its dividend regularly at impressive rates. For example, in 2016, the company raised its dividend by 13%.
The dividend appears to be sustainable based on the fundamental position of the company. Operating EPS of $2.64 per share easily cover the 68 cents per share annual dividend.
It would take a sustained, major decline in 2017 and beyond to jeopardize the dividend.
Judging by the market’s reaction this year, however, investors do not seem convinced. The stock trades for a price-earnings ratio of just 5.3.
Final thoughts
The cascade of negative headlines has stoked fear among investors, and the company’s weak first-quarter earnings only added fuel to the fire.
Throughout the year, AmTrust has consistently reiterated there is nothing wrong with its loss reserves or other accounting methods. It is entirely possible the SEC probe will find no wrongdoing by the company.
The company is investing additional resources to improve its financial controls and remedy the various issues that have impacted the stock in 2017.
Meanwhile, its underwriting and investment operations continue to perform well.
If the SEC investigation comes back clean, AmTrust stock appears to be an attractive bargain based on valuation and its high dividend yield.
Disclosure: I am not long any of the stocks mentioned in this article.
