RNR - AXIS Capital Outperforming Now But There's Not A Lot To Get Excited About

Summary

• AXIS Capital beat expectations for the fourth quarter, with better-than-expected core losses in insurance and much better investment earnings driving the beat.
• Pricing is still okay, but I am concerned that pricing isn't running much ahead of loss trends and that AXIS isn't booking particularly lucrative business.
• AXIS's exit from prop-cat reinsurance makes sense, but it came ahead of one of the hardest markets in recent memory.
• I can support a fair value up to around $70 for AXIS, which isn't bad but it's not enough to motivate me to own the shares, particularly given lackluster end-market trends.

Credit where due – AXIS Capital ( AXS ) did what it needed to do in the fourth quarter and surprised investors with better loss trends in the Insurance business and better investment income. Premium growth was healthy, pricing seems to be okay, and management took advantage of an opportunity to take care of some potentially problematic reserves. It was a good quarter, and the stock price reaction reflects that.

Even so, I find it hard to work up a lot of enthusiasm to own the name. Moving out of property cat reinsurance may make sense in terms of capital efficiency and reducing long-term earnings volatility, but exiting ahead of the hardest prop-cat market in around 20 years leaves money on the table. Moreover, it’s not clear to me that AXIS is getting pricing much ahead of loss trends, which doesn’t to me any sort of “coiled spring” of future earnings upside. The stock doesn’t look pricey to me, and I can argue for a fair value close to $70, but I just can’t work up much enthusiasm for owning this name.

Getting It Done In The Fourth Quarter

There were some nits to pick in the results that AXIS reported, but overall it was a good quarter that beat expectations where it needed to, and the guidance for 2023 was fairly constructive.

Gross premiums rose about 15% in constant currency, with Insurance up 15% and Reinsurance up 19%. Within Insurance, professional lines was the only area of decline (down 4%), while property, credit/political risk, accident & health, and marine/aviation were all up more than 20%. Casualty was also strong, while cyber was softer (up a little less than 3%). Net written premiums were likewise strong, rising 20% for both the Insurance and Reinsurance businesses.

Net premiums earned rose more than 8%, with 15% growth in Insurance and a 1% contraction in Reinsurance.

The accident-year combined ratio worsened slightly (50bp to 90%), but Insurance improved by almost five points (to 81.6%), driving good upside, while Reinsurance worsened by about eight points (to 93.7%) but was also still better than expected. In both cases core loss ratios were better than expected, though more so for Insurance.

Underwriting income declined 3% from the year-ago period, but still beat by close to 20%, with Insurance improving 51% from the year-ago level, while Reinsurance dropped 84% on pressure from cat losses.

Net investment income was a big contributor, growing by about 15% and generating more than twice as much upside (relative to sell-side estimates) as the underwriting income line. After-tax yield improved to 3.78% (up 154bp qoq), and the company also saw good performance in its alt investment portfolio. At the end of it all, AXIS beat by about $0.20/share, or a little better than 11%.

Insurance Trends Are Positive, But I’d Argue Not Dramatically So

AXIS reported overall Insurance pricing improvement of 6%, with North American pricing up 4% and international up 8%. That’s basically consistent with what a lot of sell-side surveys were projecting, as well as the comment on industry pricing from broker Brown & Brown ( BRO ) when it reported earnings.

Pricing in property is still strong (up 10%), while casualty is more mixed, including 4% growth in excess. Professional lines pricing continues to deteriorate, with AXIS seeing 2% improvement this quarter. Reinsurance pricing was up 11%, with healthy trends in specialty reinsurance, but not nearly on par with what’s happening right now in prop-cat reinsurance.

The “but” is that it doesn’t look like pricing for AXIS is improving all that much beyond underlying loss trends (which management described as “mid-single-digits”). That’s one of concerns about where the P&C market is now, as pricing is largely being driven by loss trends and while that’s good for insurers with better-than-average underwriting, it’s not as potent for more average (or worse) underwriters.

AXIS bulls will likely disagree with me here, but I don’t think AXIS’s underwriting is all that special. The ratio of paid to incurred losses has been running close to 100% here of late, with first-year paid losses also trending higher. Given a general shift away from property, it should be improving, and so I wonder about underlying reserves.

With that in mind, I’d also note the loss portfolio transfer agreement with RiverStone announced back in December. This agreement covers $400M of reserves (up to $605M) in professional liability and liability from 2019 and before. Management said it was an “opportunistic” deal that is accretive to ROE, but the reality is that you don’t pay someone to take care of your problem children unless you need to, so I do think questions about reserves and future reserve development are at least fair to ask.

The Outlook

At this point, I would say the outlook for AXIS’s core primary insurance operations is “okay”, but not great. I just don’t see a lot of momentum in P&C pricing ahead of loss trends at this point, so I’m not all that excited about the business that’s going to be written over the next couple of years.

Unfortunately, management chose to exit the prop-cat reinsurance market earlier this year … ahead of one of the hardest markets in 20 years. After years of weak rates and overcapitalization, alt capital fled the space and now reinsurers are seeing robust rates on top of higher attachments points and more limited coverage.

I’ve seen estimates that companies like Arch Capital ( ACGL ), Everest Re ( RE ) and RenaissanceRe ( RNR ) will be writing prop-cat reinsurance business at 30% ROEs on normal cat losses, and for superior underwriters like this, it could almost be a license to print money in some cases. So while I understand AXIS’s decision to leave the business, it’s painful to see that money left on the table.

Improved investment earnings will provide a boost to earnings in the near term, and I do think AXIS can generate mid-single-digit core earnings growth over the longer term. That’s good enough to support a fair value close to $70. I likewise get a high-$60’s fair value through my ROE-based P/BV approach, with a near-term ROE of 13.5% supporting a 1.45x multiple.

The Bottom Line

I don’t have any particular issues with AXIS beyond some concerns about recent reserve trends and the fact that it’s not leveraged to markets I find particularly exciting in the near term. It’s an okay company, and if the shares were trading in the mid-$50s, I’d be a lot more interested. As it stands, though, it’s just not high on my list of potential buy ideas today.

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