Warren Buffett (Trades, Portfolio) has always loved insurance companies. Some of his earliest, highest-conviction investments, such as GEICO and Western Insurance, were insurance plays. When he finally took over Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), insurance was the industry he chose to expand the business into.
Buffett’s love of insurance is based on several traits unique to the industry. First, insurance can be a highly profitable industry.
Second, insurers have what is called float, which is made up of excess premium income, to cushion any losses in bad years. Early in his career, Buffett discovered float is a great vehicle to invest with due to tax advantages and the permanent nature of the capital.
Third, insurance companies tend to be undervalued as they are often difficult for industry outsiders to understand. For example, in a screen of the 154 companies in the U.S. insurance sector, just over half are trading at or below book value.
A Buffett-style stock?
Security National Financial Corp.Ă‚ (SNFCA, Financial) is a great example. Security National is a holding company with three principal segments: life insurance, cemetery and mortuary and mortgage loans. What is interesting about this business is that as well as offering lucrative insurance products, it also operates seven mortuaries and five cemeteries in the state of Utah and a cemetery in the state of California. The shares are currently trading at a price-book ratio of 0.6, price to tangible book value of 0.64, price to free cash flow ratio of 1.3, price-sales ratio of 0.3 and EV/EBITDA ratio of 5. On all metrics, the company looks cheap. So what has gone wrong?
It appears the company is facing headwinds in all but one of its markets. For the three months ended June 30, Security National’s pre-tax earnings from operations decreased 50%, from $7,986,000 in 2016 to $3,994,000 in 2017, on an 8.6% decrease in revenues to $73,172,000. First-quarter mortgage origination volume was down 5%, and second-quarter volume was down 17%. Sales also fell by a double-digit percentage on the memorial side of the business. On the insurance side, however, revenue rose 9% and an 11.9% improvement in profitability was reported, although depressed interest rates held back profitability on the company’s investment portfolio, meaning “achieving the yields necessary to increase profitability remains challenging.”
Creating value
It is clear Security National is facing challenges, but over the medium term, the company has a strong record of creating value for shareholders. Since 2011, the company has grown book value per share at a compound annual rate of 25.3%, from $2.9 to $8.8 at year-end 2016. Over the same period, the share count has remained relatively stable, indicating most of the growth has come from retained profits.
An interesting factor to point out is the company recently restated its financial statements for the year-end 2014, 2015 and 2016 and first-quarter 2017 periods. The result of the restatement was an increase in total assets and liabilities of approximately $98,000,000 for 2016 due to the “recharacterization of pre-existing warehouse financing agreements.” Most of the other changes were non-material. Despite these changes, book value has continued to increase, rising to $9.05 as of June 30 from $8.83 as of December 31, 2016, according to the second-quarter figures.
The bottom line
Security National is cheap. Despite the company’s problems, there is already a lot of bad news baked into the valuation. In a market where deep value is difficult to find, this company might deserve a second look. If it can continue to compound book value at its current rate, even if the valuation gap does not close, a double-digit annual return is possible.
Disclosure: The author owns no stocks mentioned.
