CINF - Cincinnati Financial: A Dividend King At A Favorable Valuation

Summary

• Cincinnati is growing strongly, with 13% growth in premiums than in the same period last year. Investment income was also up 8% thanks to Fed rate hikes.
• As interest rates rose, the stock market declined, and Cincinnati's stock portfolio fell $674 million, causing total revenues to decline by 21% compared to the same period last year.
• When the stock market recovers, these unrealized losses will result in gains.
• The stock is buyable because of premium growth and investment income and because the stock trades favorably in the market.

Introduction

Cincinnati Financial (CINF) is a property and casualty insurer that has had a successful decade. Its total stock return is comparable to the S&P500, with an average annual return of 13.5%.

Due to the high inflationary environment, Cincinnati has significantly increased its premiums. The Fed is raising interest rates to address high inflation. When interest rates rise, Cincinnati's investment income increase significantly. The stock portfolio has fallen dramatically, but if the market improves, these unrealized losses could turn into gains. The stock is buyable because of premium growth and investment income, and because the stock trades favorably in the market.

Company Overview

The Cincinnati Financial Corporation is a financial services company based in Cincinnati, Ohio. It was founded in 1950 and is the parent company of Cincinnati Insurance, a property and casualty insurance company that provides personal and business insurance products in the Midwest and Southeast regions of the United States. Cincinnati Financial Corporation also operates a number of subsidiaries that offer a variety of financial products and services, including life insurance, investment management, and retirement planning. The company has a strong commitment to customer service and has consistently received high ratings for financial strength and stability from independent rating agencies. Cincinnati Financial Corporation is listed on the NASDAQ stock exchange.

Third Quarter Results Were Mixed

Earned premiums totaled $1.9 billion in the third quarter , a 13% increase over the same period last year. Investment income was $193 million, up 8% from the same period last year. Investment losses totaled $674 million, resulting in a 21% decrease in total revenue compared to the same period last year.

Non-GAAP operating income of $114 million for the third quarter of 2022 was down $95 million from the same period last year, due to higher after-tax catastrophe losses of $19 million. Cincinnati's third-quarter property casualty combined ratio of 103.9% was 11.3 percentage points higher than the previous year's third-quarter figure of 92.6%. Inflationary pressures resulted in increasing loss ratios and greater estimated ultimate losses.

Underwriters have raised expectations to address current inflationary trends in areas including risk selection criteria, pricing of policies, and changing premium factors for changes in risk exposure. This is in addition to a variety of premium rate increases.

As the stock market declines while the Fed is raising rates, third quarter earnings came in with a net loss of $418 million ($2.64 per share), compared with net income of $153 million ($0.94 per share) in the third quarter of 2021, after recognizing a $557 million third quarter 2022 after-tax reduction in fair value of equity securities held.

Cincinnati generates income from its insurance operations, fixed income securities, but also from its equity portfolio. The complete list of equity portfolio is given on its company's investor relations website.

The list shows us that the company's top three equity investments are in Baxter International ( BAX ), Broadcom ( AVGO ), and Mondelez ( MDLZ ) with portfolio allocations of 4.6%, 3.8%, and 3.3%, respectively.

As with Berkshire Hathaway ( BRK.A ), earnings are distorted by new GAAP accounting rules implemented in 2018. Unrealized investment gains and losses are recognized in the income statement.

Short-term unrealized losses are not significant to the company because the losses are still unrealized. After the stock market recovers, those unrealized losses lead to gains. Excluding the unrealized losses, the company performed strongly in the third quarter of 2022.

Dividends And Share Repurchases

Cincinnati Financial Corporation has a strong track record of increasing its dividends over time, with a consistent pattern of annual dividend increases for more than 50 years. Over the past 5 years, the dividend has risen an average of 5.6% per year. The dividend is $2.76 and the dividend yield is 2.7%.

A closer look at the cash flow statement shows that cash flow for dividends has not changed much over the past 5 years. The company repurchases shares and the buyback yield averages about 1% per year.

Share repurchase, also known as buyback, refers to the practice by which a company buys back its own outstanding shares in the open market. Companies may choose to repurchase their shares for a variety of reasons, including to improve financial performance by reducing the number of outstanding shares, to return excess cash to shareholders, or to increase the value of remaining shares by reducing the supply of available shares.

Share repurchases can have a positive impact on a company's stock price, as they can increase the demand for the company's shares and reduce the supply of available shares, which can drive up the price.

By reducing the number of shares outstanding, earnings per share will increase, but so will dividends per share. The dividend per share has been growing steadily for years, while the cash flow for the dividend does not change much.

In the table the shareholder payout ratio is calculated, which is a metric that measures the percentage of a company's free cash flow that are paid out to shareholders in the form of dividends plus share repurchases plus share issuances. A favorable ratio is one that is sustainable over the long term and allows the company to continue return cash to shareholders while also retaining enough cash to invest in the growth of the business. A ratio below 1 indicates that the return to shareholders is less than the company generates in free cash flow. Year to date, the ratio is 0.5, indicating a sustainable return to shareholders for the long term.

The Stock's Valuation Looks Favorable

Let's take a look at the company's stock valuation. There are many different methods and techniques that can be used to value a company's stock. Some common methods of stock valuation include discounted cash flow analysis, price-to-earnings ratio, price-to-sales ratio, and dividends discount model. As GAAP earnings per share have declined significantly, the price relative to free cash flow may provide a more accurate picture of the stock's valuation.

The company's P/E ratio is currently 9.0, which is below the three-year average of 10.2. In general, a P/E ratio of 9 is considered favorable.

It is important to note that stock valuation is a subjective process, and different analysts and investors may arrive at different conclusions about the value of a company's stock.

Look at the P/B. Generally, a P/B over 2 is considered expensively valued for insurance companies. Cincinnati's P/B ratio of 1.8 sounds favorably valued, but historically the stock trades above its 3-year average of 1.6. The company is still growing and if interest rates rise, profits will increase. Therefore, the stock is worth buying.

Conclusion

Cincinnati is a property and casualty insurance company based in the United States that offers personal and commercial insurance. Cincinnati Financial Corporation also has a number of subsidiaries that provide financial products and services such as life insurance, investment management, and retirement planning.

The company is growing strongly, with 13% growth in premiums than in the same period last year. Investment income was also up 8% thanks to Fed rate hikes. As interest rates rose, the stock market declined, and Cincinnati's stock portfolio fell $674 million, causing total revenues to decline by 21% compared to the same period last year. The decline in the stock portfolio was due to unrealized losses. When the stock market recovers, these unrealized losses will result in gains. Cincinnati's combined ratio was high at 104% due to inflationary pressures and led to an increase in premiums.

The company has a strong track record of dividend increases over time, and over the past 5 years the dividend per share has increased an average of 5.6% per year. The stock's valuation looks attractive at this level. The stock is buyable because of premium growth and investment income, and because the stock trades favorably in the market.

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