HIG - Hartford Financial: Catalysts Are Playing Out As Expected

2023-11-21 06:59:34 ET

Summary

• HIG's recent shareholder capital return in the form of dividends and buybacks is decent, and medical inflation hasn't had a meaningful impact on the profitability of the Workers' Compensation business.
• Hartford Financial's Group Benefits business has surprised the market in a positive manner with its substantial ROE expansion for the recent quarter.
• I still rate HIG as a Buy, as the catalysts for the stock are playing out well as per my expectations.

Elevator Pitch

I continue to have a Buy rating awarded to The Hartford Financial Services Group, Inc. (HIG).

With my prior September 12, 2023, initiation article , I highlighted that HIG was trading at a discount to fair value with catalysts such as the above-expectations profitability of the Workers' Compensation business and sustained share repurchases. As per Seeking Alpha price data, Hartford Financial's share price rose by +7.1% and outperformed the S&P 500 by +5.5 percentage points following the publication of my earlier write-up.

In the latest update, I touch on how the potential catalysts for Hartford Financial are playing out and the improvement in ROE for the Group Benefits business. HIG continues to distribute excess capital to its shareholders, while the Workers' Compensation business hasn't been negatively impacted by medical cost inflation in a big way. In addition, the Group Benefits business has been a positive surprise with a significant increase in ROE thanks to healthy unemployment numbers. Therefore, there are multiple reasons to stick with a Buy rating for Hartford Financial.

HIG's Shareholder Capital Return Continues To Be Impressive

I previously noted in my September 12 article for HIG that I expected "continued share buybacks" for the company. Hartford Financial is still returning a significant amount of excess capital to shareholders as evidenced by its recent quarterly capital return activity.

As indicated in its Q3 2023 earnings press release , Hartford Financial spent $350 million on share buybacks in the third quarter of this year. It is noteworthy that HIG had also bought back $350 million worth of its own shares each for both the first quarter and second quarter of the current year. In other words, Hartford Financial has maintained the same level of quarterly share repurchases in 9M 2023.

Looking forward, HIG guided at its Q3 2023 earnings briefing that "we expect to remain at that level of repurchases in the fourth quarter." This implies an annualized share buybacks of $1.4 billion for full-year FY 2023, which represents a meaningful 6.0% of Hartford Financial's current market capitalization.

Hartford Financial's shareholder capital return isn't just limited to buybacks. HIG raised its quarterly dividend distribution per share by +11% to $0.47 when it announced its Q3 2023 results, which marked the 10th dividend hike for the company in the past 10 years.

HIG's consensus forward fiscal 2023 dividend yield is 2.2% , while the company's expected buyback yield for the current fiscal year is 6.0% (buybacks divided by market capitalization). This implies that Hartford Financial's FY 2023 shareholder yield (sum of dividends and repurchases divided by market capitalization) could be as high as 8.2%.

A sustained level of share buybacks and the company's recent dividend hike are likely to drive a favorable re-rating of Hartford Financial's valuations, as it is highly probable that the market rewards HIG for its impressive shareholder capital return.

Workers' Compensation Business Has Performed In Line With Expectations

With my September 2023 initiation piece, I outlined my opinion that HIG' "Workers' Compensation business" will be "largely unaffected by medical inflation" thanks to the company's "claim capabilities" and "multi-year contracts." My view has been validated by Hartford Financial's recent management commentary and disclosures.

At the company's recent third quarter results call, Hartford Financial stressed that "we haven't made any changes in frequency or medical assumptions since" the start of 2023, and emphasized that HIG won't be "surprised in any way, shape or form on medical severity running away from us." In specific terms, HIG's full-year FY 2023 medical severity estimate is approximately 5%, while the actual 9M 2023 medical severity level is lower at between 2% and 3%.

As such, I see the Workers' Compensation business posting better-than-expected profitability, which will be a positive surprise for the market.

Group Benefits Business Witnessed ROE Expansion

The trailing twelve months' adjusted core earnings ROE for Hartford Financial improved from 14.3% in the third quarter of 2022 to 14.7% for the most recent quarter.

A key driver of HIG's ROE increase at the company level was the ROE expansion for its Group Benefits business. The Group Benefits division is the second largest business (after Commercial Lines) for Hartford Financial accounting for 29% of its top line, as disclosed in HIG's Q3 2023 results presentation slides .

HIG's Group Benefits Business Is A Leading Player In The Key Segments It Operates In

The Group Benefits business' adjusted core earnings ROE more than doubled from 6.6% for Q3 2022 to 13.8% in Q3 2023. The recent third quarter ROE for the Group Benefits segment also implied a +130 basis points expansion on a QoQ basis. Also, if adjusted for goodwill relating to M&A, the Group Benefits business' ROE would have been even higher at around 17% for the most recent quarter.

At its Q3 results briefing, HIG attributed the outperformance of the Group benefits business to the mortality rate normalizing and being "slightly ahead of our expectations", and the fact that "unemployment is at very low levels" now. The latest October 2023 unemployment rate is still fairly healthy at 3.9% , so this bodes well for the Group Benefits business' near-term earnings and ROE prospects.

Final Thoughts

HIG's Buy investment rating remains unchanged. The earlier catalysts that I identified are playing out well, and the Group Benefits business has delivered reasonably good ROE improvement.

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