CNA - CNA Financial Started 2023 On The Right Foot

2023-05-01 17:15:11 ET

Summary

• CNA Financial started 2023 on the right foot by delivering more-than-decent first-quarter results.
• Despite lower underwriting performance, the net income was flat compared to last year in the same period due to higher investment income.
• A dividend seeker might enjoy investing in CNA Financial, even though the company is reasonably valued (1.2x the book value).

Executive Summary

CNA Financial ( CNA ) recently released its first-quarter results.

The net income remained flat at $297 million, driven by higher investment income, offset by a lower underwriting income, resulting from a higher combined ratio.

The higher yields on fixed-income securities continued to be a significant earnings tailwind. The effective income yield on fixed income increased from 4.3% to 4.6% year-over-year, and the fixed-income portfolio generated a pre-tax income of $479 million.

On the underwriting performance side, the combined ratio remained more than decent at 93.9%, despite the higher catastrophe impacts and the adverse prior-year claims development.

While the current valuation is not attractive for greedy investors, the insurance company started 2023 on the right foot, showing steady underwriting and higher investment results.

Strong Production Metrics Despite Deteriorated Underwriting Margins

The P&C segments posted a premium growth of 10%, driven by a high retention rate (86% overall) and a premium rate increase of 5%.

The specialty business, which is the cash cow of the insurance portfolio, delivered a steady 90% combined ratio, vs. 88.7% in Q1 2022.

A higher expense ratio and no positive run-off for the quarter drove the deterioration in the combined ratio. However, the underlying loss ratio improved by 0.5 points to 58.4%

The commercial business recorded an excellent top and bottom-line performance for the quarter. The premium grew by 16% on a net of reinsurance basis, driven by a 7% rate change and an 86% retention rate.

At the bottom-line level, the impact of the catastrophe costs adversely affected the loss ratio by 4.2 points. In contrast, the underlying loss ratio remained flat at 61.5%, and the expense ratio dropped from 30.7% to 29.8%.

The international activities recorded lower underwriting gains due to an adverse run-off representing a 5.1-point impact on the loss ratio. Furthermore, the catastrophe losses were higher than in Q1 2022, affecting the loss ratio by 2.8 points.

Despite the reduction in the expense ratio, because of the earned premium growth (+ 10% on a net basis), the underwriting income reduced from $20 million in Q1 2022 to $9 million in Q1 2023.

Higher Yields: Costs and Benefits

CNA Financial, like other insurers, has benefited from the increase in the fixed-income average yields. 90% of the investment portfolio is invested in fixed-income securities, with an average credit rating of "A."

On the liability side, the company's debt is $2.87 billion, or a debt-to-capital ratio of 24.3%.

The debt maturities range from 2023 to 2030.

Although the debt rollover should prove more costly for the company as interest rates rise, the company's credit rating quality (A+/stable from S&P and Fitch) should ensure contained costs compared to lower-rated peers.

Current Valuation

The book value per share is currently $32, or a price-to-book valuation of circa 1.2.

Based on that metric, the company seems relatively inexpensive. Investors might consider CNA Financial undervalued compared to peers, as other property and casualty insurers trade at 1.5x their book value or more.

However, there are two drivers regarding the relative "undervaluation" of CNA Financial. First, CNA Financial is almost 90% owned by Loews ( L ). In other words, CNA could be at the mercy of Loews' good or bad decisions regarding capital allocation.

Second, other peers deliver a better operating performance (e.g., Chubb ( CB ) with a lower combined ratio) or record more substantial investment results, like Cincinnati Financial ( CINF ), due to a higher part of the investment portfolio allocated to equity securities.

Small Potential Upside But Recurring Dividend Income

CNA Financial is neither a fast-growing insurance company nor an undervalued stock. CNA shares are traded at around 1.2 - 1.4 times the book value. The upside potential is quite limited, as the company is majority-owned by another company. Nonetheless, the insurer generates recurring cash flows due to steady positions in niche markets, which allow it to redistribute the capital excess to its shareholders over the cycle without endangering its solvency position.

CNA remains a good option for all retirees or dividend-oriented investors. They might consider buying the stock when it is traded at circa 1.0 times the book value if they want to purchase a portion of the company with a safety margin.

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