SSREF - AXIS Capital: Quality Play At A Reasonable Price

2023-05-19 13:58:54 ET

Summary

• We stamped a buy on AXIS Capital Holdings the last time around.
• Valuation was compelling, and the firm was delivering results.
• The company has made some big moves and moved away from the extremely volatile catastrophe reinsurance segment.
• We look at the new, leaner AXIS.

On our last coverage of AXIS ( AXS ), we were impressed enough to go with a buy versus the usual "hold".

We are stamping a buy here with the caveat here that we don't think the reinsurance segment will be sold on a stand-alone basis. If it is, we will reassess what is left after that deal.

One could claim the outcome as a small victory.

But that would be wrong. While AXS has done well here, relative to the market, it has really lagged the broader reinsurance sector. Everest Re Group ( RE ) was the clear winner, RenaissanceRe ( RNR ) was not too far behind. Even the normally slow-moving Swiss Re AG ( SSREF ) ( SSREY ) did almost 38%. We were in the right church, but definitely in the wrong pew.

Let's look at whether this is an opportunity for AXS to catch up and make investors some solid returns in the next 12 months.

Q1-2023

While an outright sale of the reinsurance segment did not materialize, AXS has been repositioning its underwriting rapidly. In fact, that repositioning is why the major brokers moved to a less optimistic stance.

Wells Fargo on Friday downgraded AXS to Underweight from Equal Weight as it expects the insurer to miss out on the "hardest catastrophe reinsurance market seen in decades", putting it at a disadvantage vs. peers.

AXS exited the property and catastrophe reinsurance business to position itself as a specialty insurer.

"Our sense is reinsurers expect the business could offer an ROE in the range of 30%, assuming a $90B global industry loss year. Given AXS exited writing the business, it will not be able to leverage stronger pricing expected in 2023 (and beyond)," said analyst Elyse Greenspan.

"Those without a catastrophe offering are likely in a position to lose share on casualty business to reinsurers with a fuller offering," she added.

Source: Seeking Alpha

That sounds like someone selling their stock just before it takes off. We agree with the analyst that the reinsurance market has strengthened by leaps and bounds over the last 12 months, and AXS winding this down has not worked for it. That said, let us look at the results.

AXS beat estimates handily and net income for Q1-2023 was $173 million, or $2.01 per share. Operating income was even stronger at $2.33 per share. Both numbers were about 15% higher than last year. Book value per share increased by $3.36 at an annualized 28% rate vs last quarter. All of this was achieved with net and gross premiums falling by about 11% as AXS continued to exit non-specialty reinsurance.

Turning now to our reinsurance segment. Our reinsurance team continued its repositioning of the business to a more focused specialist reinsurer, targeting lines that complement and are accretive to our broader specialty portfolio strategy. The headlines are, for the quarter, we delivered a combined ratio of 91% and generated underwriting profits of $36 million. This was a solid result for the quarter as we further transition into a specialist reinsurer.

During the quarter, we generated gross written premiums of $966 million, which is down 26% from the prior year period. Our available renewals were about $340 million less than last year. Of that, we had a premium retention rate of 83% as we nonrenewed business that in our estimation is not accretive to our overall portfolio. Our renewed business where we achieved an average rate increase of 12%.

Source: AXS Q1-2023 Transcript

That 12% jump sounds great, and it is a net positive for AXS. But let's compare that to how the ones that embraced the catastrophe reinsurance segment did.

We targeted attractive opportunities to grow with trusted partners and materially improved risk-adjusted returns. Our practice of setting clear and consistent expectations early with clients and brokers led to significant improvements in pricing and terms and conditions across our portfolio, while building long-term relationship equity. That excess of loss pricing is excellent with risk-adjusted rate changes at January 1 of plus 50% in North America and over 40% international.

Our momentum continued at the April redo, where pricing remained strong, up 44% in North America and 26% in international.

Source: EverestRe Q1-2023 Transcript (emphasis ours)

So there is that. On the other hand, despite such great tailwinds that have been in place for catastrophe reinsurance, EverestRe delivered 17% annualized return on equity this quarter compared to 28% for AXS. That is because what reinsurance gives, catastrophes take away. The hard market has come about as many balance sheets have been decimated by repeated losses. AXS moving to a less volatile and less dangerous area of the market could create premium pricing for its equity down the line.

Outlook & Verdict

Albert Benchimol has moved on from AXS and Vince Tizzio has taken his place at the helm. There is a lot of work to do as AXS transitions to a primary specialty reinsurer. As the analyst above stated, regular reinsurance companies should be able to generate 30% annualized returns on equity in a year, probably for 2-3 years. AXS is likely to come in near 15%. But that 15% will likely be more consistent, and we will see very few if any negative years. We will note that AXS is still winding down its book, so it has big catastrophe exposure for 2023. But beyond that, we may well see a company that produces more consistent profits. Analysts are modeling a 15% return on equity and if they can do even 12% average annualized, with very few really bad years, the stock is cheap.

The company has lagged some of the names we mentioned earlier, even over long periods. But it has outperformed the iShares U.S. Insurance ETF ( IAK ) over the same time frame.

We think there is still an opportunity here for AXS to continue to do so. Valuation is not that demanding, and the stock trades close to tangible book value (adjusted for AOCI). It is also an excellent way to play the "higher for longer" rate thesis as AXS has a lot of float that is gradually resetting to higher interest rates. We rate the shares a buy and look for $60 by year-end for a total return of about 9%. A defensive way to play this would be the $55 covered calls, which would produce a better total return, with less risk.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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