PEP - Everest Re: The Drivers Behind The Big Rally

Summary

• Everest Re has delivered a spectacular outperformance versus the market.
• The stock is benefitting from the hardest markets for reinsurance pricing.
• We examine whether you can make money by buying today or whether it is better to stand on the sidelines.

Everest Re Group, Ltd. ( RE ) is global provider of both insurance and reinsurance products, with the latter taking up more of the shelf space.

We called it an ultra quality play the last time we wrote on this A-rated business. Due to the lofty market levels at the time (June 2021) and with the hurricane season on our doorstep, we cautioned our readers to wait for pullback opportunities.

RE should be one on everyone's watchlist. The company has shown the ability to grow through thick and thin and has absolutely demolished the growth stock indices. If you get a chance to buy this under tangible book on a hurricane scare, you should definitely consider it. We are looking to sell another round of cash-secured puts on this one as well, but our current portfolio is already chock full of reinsurers of every stripe . Although, if the price gets compelling enough, you can bet we will make room for this one.

Source: Everest RE: An Ultra Quality Play To Keep On Your Buy List

Interested buyers got a few opportunities to make double digit returns from that point. With the last quarter returns just around the corner, we provide our current thoughts and what we expect.

Reinsurance Boom

It took some time coming through, but it finally happened. Years of high degree of catastrophe damage, finally destroyed enough equity in the business. The ones that underwrote policies at bad prices just took too many hits to be competitive.

In its renewal report titled The Great Realignment, Howden noted how high inflation, interest rate hikes, depleted capital, fractured energy markets, the Ukraine war, and Hurricane Ian have coalesced to tip the reinsurance sector into “significant volatility,” resulting in “one of the hardest reinsurance markets in living memory.”

In the midst of these challenging conditions, there was capital erosion of 15.7% to US$355 billion in 2022. This, according to Howden, marked the first full-year decline since 2008. Significantly higher premiums drove the sector’s solvency margin ratio (capital divided by premiums) below 100 as reinsurers were also left more exposed to liquidity and credit risks.

Source: Insurance Business Mag

Others, like Axis Capital Holdings Limited. ( AXS ) felt that the business was not worth it, despite the high double digit increases in renewal rates. AXS itself had mentioned this as a big positive pretty much from the middle of 2021 till late 2022, when it decided to actually exit the reinsurance segment . The end result has been pricing like we have never seen before.

Howden said its Global Property-Catastrophe Risk-Adjusted Rate-on-Line Index grew by an average of 37% at the January 1 renewals, compared to the 9% recorded in the previous year. This was the highest year-on-year increase recorded by the global broking group since 1992.

In Europe specifically, the market suffered significant catastrophe losses as a result of the European windstorms early in the year and the hailstorms that battered France over the summer. There was also strong demand for additional limits to counter inflation, as well as some retrenchment from incumbent reinsurers.

Together, these factors led a “challenging environment for buyers,” the Howden report said, with higher attachment points, more stringent terms, paid reinstatements and a rate increase of 30% on average. However, capacity was “sufficient to see most deals over the line,” particularly for those who were able to “demonstrate strong performance and/or leverage long-standing relationships.”

Source: Insurance Business Mag (emphasis ours)

There are other estimates floating out there and they all range from high to "are you kidding me?

James Kent, global chief executive at reinsurance broker Gallagher Re, which published the report on Tuesday, described it as a “very late, complex and in many cases frustrating renewal”. The cost of aerospace reinsurance rose by between 150 per cent and 200 per cent , as reinsurers adjusted pricing in the light of a revaluation of past losses, as well as expected payouts from stranded planes and a legal battle with leasing companies in the wake of Russia’s invasion of Ukraine. Property catastrophe reinsurance, which shoulders losses from hurricanes and other natural disasters, also jumped, with rates in the US increasing by between 45 per cent and 100 per cent for loss-hit policies, according to Gallagher Re’s figures. The broker put this down to the impact of Hurricane Ian, which struck Florida and South Carolina last year, as well as the threat from inflation, which drives up payouts.

Source: Financial Times (emphasis ours)

So this is the best possible market and the earnings estimates show that.

Assuming 2023 is an average year in terms of losses, Everest should make near $45 a share in earnings. You can see how this stands out relative to its history.

That number should improve further as reinsurers often have multi year contracts that are repriced biannually. We could see upwards of $50 per share in 2024.

Verdict

Everest is getting the benefit for pricing tailwinds and a big bump up from higher interest rates. Unlike banks, insurance and reinsurance companies are yield curve agnostic. They benefit from higher interest rates, independent of what happens to the yield curve. This works for them as their older lower interest rate investments get reinvested at higher market rates. That factor has also added in the earnings estimates. Of course when everything looks great, it is easy to buy. You can get seduced by the ultra-low P/E and promises of fat profits. Unfortunately, nothing in the market is that easy. There are three things we would consider here before jumping in.

The first is that those estimates assume an average catastrophe year. They could very well be better than that or significantly worse. Look at Everest's earnings over the years (above). There is nothing smooth about it. You are not buying PepsiCo, Inc. ( PEP ) or Kellogg Company ( K ) here. You might get $55 in earnings per share in 2023 or you could get a $20/share loss.

The second is that hard pricing inevitably creates low pricing. This might take one good year, or three, but at the end of the day you will see lower pricing for reinsurance. How long the cycle lasts is anyone's guess but this is a cycle and that won't change.

Finally, one objective look at valuation that is unburdened by unpredictable earnings, is price to tangible book value. That number looks like this.

There is a little bit more nuance to it when interest rates rise rapidly and the bonds held by the company temporarily have to be marked down. This ratio can appear a bit overstated. You can see this worked out in the company's financial statements .

But whichever way you cut it, the company is not cheap. If Everest makes a collective $100 in earnings over the next three years and then trades back at tangible book value, you would make almost nothing in price appreciation over the next three years. The sector is certainly flying today and we salute those that bought in before the rally. But at present the best we can give this is a "hold".

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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