CINF - Cincinnati Financial: Wait For Further Correction Of This High-Quality Dividend King

2023-05-24 06:08:48 ET

Summary

• Cincinnati Financial is a high-quality Dividend King, with 62 consecutive years of dividend growth.
• Since my article almost two years ago, CINF stock has declined 11%.
• Nevertheless, the stock remains somewhat richly valued. As a result, investors should probably wait for a further correction of the stock before purchasing it.

Almost two years ago, I recommended waiting for a correction of Cincinnati Financial (CINF) due to its rich valuation back then. After that article, the stock declined 19%, primarily due to the impact of high interest rates on its investment portfolio, until it bottomed in October 2022. At that point, I recommended purchasing the stock, as I considered the headwind from interest rates temporary and the valuation of the stock attractive.

After the second article, the stock rallied 33% in about four months and peaked in early February. Since it peaked, Cincinnati Financial has declined 20%, mostly due to the effect of high interest rates on its book value and concerns that the latest economic slowdown and turmoil in the financial sector may affect its business momentum. Thanks to its high-quality business model, the insurer has easily endured the downturn caused by the aggressive interest rate hikes implemented by the Fed and the reduced economic activity. Nevertheless, the stock remains somewhat richly valued. Therefore, investors should probably wait for a further correction of the stock.

Business overview

Cincinnati Financial provides property and casualty (P/C) insurance products in the U.S. The P/C insurance business warrants special attention, as the earnings in this business are highly volatile due to the unpredictable nature of the loss claims. It is thus critical to evaluate an insurance stock based on its long-term performance record.

Cincinnati Financial has a consistent growth record for a P/C insurance company. During the last decade, the company has grown its earnings per share at a 4.7% average annual rate and its book value per share at a 6.8% average annual rate. Moreover, the insurer has somewhat accelerated its growth pace over the last four years, as it has achieved an average annual value creation rate of 11.2% during this period.

Source: Investor Presentation

The value creation rate is equal to the growth rate of the book value per share plus the dividend yield. Given all the above performance metrics, it is evident that Cincinnati Financial is a disciplined insurer, which follows a prudent long-term growth strategy instead of focusing on short-term results.

Another testament to the high-quality management of this company is its exceptional dividend growth streak. Cincinnati Financial is a Dividend King, with 62 consecutive years of dividend growth. This is an impressive achievement, especially given the volatile nature of the P/C insurance business. If the company did not follow a disciplined insurance approach, it would not achieve this outstanding dividend growth record.

Cincinnati Financial has consistently grown its earnings by appointing new agencies, which have significantly grown their sales over time. As shown in the chart below, new agencies gain a small market share in their first year of operation but they then grow their market share significantly year after year.

Source: Investor Presentation

Cincinnati Financial has grown its net agency count 42% over the last decade. The growth in the number of agencies combined with the growth in the market share of these agencies have constituted the primary growth driver of the company.

Just like the other insurance companies, Cincinnati Financial generates its earnings, not only from the insurance premiums it sells to its customers, but also from the investment income of its investment portfolio. In other words, the company earns dividends and interest income from the investment of the premiums it receives from its customers in stocks and bonds.

Cincinnati Financial has a striking difference from most insurers, as it invests a significant portion of its float in stocks, whereas most insurers invest their capital almost exclusively in fixed income securities. More precisely, Cincinnati Financial has 42% of its float invested in stocks. Its diversified stock portfolio has helped the company enhance the growth rate of its book value and has also partly protected the company from the impact of high inflation on its book value, as most blue-chip stocks are more resilient to inflation than long-term bonds.

On the other hand, Cincinnati Financial is not immune to high inflation and high interest rates. Due to the aggressive interest rate hikes implemented by the Fed, which caused a sharp decrease in the value of its bond portfolio, the company incurred a 34% decrease in its earnings per share last year, from an all-time high of $6.41 in 2021 to $4.24.

However, thanks to the aggressive policy of the Fed, inflation has subsided every single month since it peaked last summer. Thanks to its determination, the central bank is likely to achieve its goal of restoring inflation to about 2% sooner or later. Whenever inflation reverts to normal levels, Cincinnati Financial is likely to retrieve its losses in its bond portfolio. Indeed, analysts expect the insurer to grow its earnings per share by 11% this year and by another 26% next year, to a nearly all-time high level.

Valuation

Cincinnati Financial is currently trading at a forward price-to-earnings ratio of 22.1 . This is only slightly higher than the 10-year average price-to-earnings ratio of 21.6 of the stock and hence some investors may claim that the stock is reasonably valued. This is true but risk-averse investors should probably pursue a lower entry point in order to enhance their margin of safety and their future returns, especially given the inevitable volatility in the P/C insurance business.

An attractive entry point for Cincinnati Financial would probably be around the strong technical support of $90, which has held firm over the last two years. Such a stock price, which is 14% lower than the current stock price, would correspond to a price-to-earnings ratio of 19.1 and a nearly 8-year high dividend yield of 3.3%.

Dividend

As mentioned above, Cincinnati Financial has an outstanding dividend growth record, with 62 consecutive years of dividend growth. The company has raised its dividend by 9% this year and thus it has grown its dividend by 6.8% per year on average over the last five years.

Moreover, the stock has a forward payout ratio of 64% . Given the aforementioned expected recovery of the earnings of the company in 2024 and its reliable business model, its dividend should be considered safe for the foreseeable future. The only caveat is the lackluster dividend yield of 2.9% . However, investors should note that the current yield of the stock is standing at a nearly 5-year high level while the insurer is likely to continue raising its dividend at a meaningful pace for many more years. Therefore, if the stock incurs a modest correction off its current level, it will become attractive for income-oriented investors.

Final thoughts

Cincinnati Financial is a best-of-breed insurance company, which has traded with a premium valuation most of the time throughout the last decade. Thanks to its disciplined business model, the company is on a reliable growth trajectory. Nevertheless, despite its underperformance over the last two years (-15% vs. a flat S&P 500), the stock remains somewhat richly valued. Therefore, investors should probably wait for an approximate 14% correction, down to the technical support of $90, before purchasing the stock.

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