UVE - HCI Group: Enticing But Not Reasonably Priced Yet

• HCI Group, Inc. remains a relatively small but durable figure in the P&C insurance industry.
• It has a strong market and financial position amidst a challenging market landscape.
• Dividend payments are continuous even if they have not increased in the last two years.
• The stock price has been moving sideways since the start of the year.

HCI Group, Inc. (HCI) remains sturdy in a stormy market environment. The challenges in Florida are evident- inflation, insurance exodus, and scams, to name a few. Even so, revenue growth and stable cash levels allow it to withstand all these. It can sustain its size and cover its borrowings and dividends. Meanwhile, the sideways movement of the stock price appears consistent with the uncertain market. It is also half of its peak in the previous year. But, it does not appear cheap, without a promise of substantial gains.

Company Performance

Insurers in Florida may be sharing similar sentiments about how harsh the market environment is for their business. It is more evident in P&C insurance companies, given the increased intensity and frequency of hurricanes. In 2021, twenty-one storms entered the U.S., making it the third year to use all the listed names. Also, it has been the third most active hurricane season ever recorded. But, more underlying problems keep bugging the industry, leading to more disruptions. That is why it appears to be on the brink of a property and casualty insurance crash. In fact, several companies have already left the state. Since 2017, the industry exodus has sped up, with six businesses liquidating and leaving the state. Recently, another three P&C insurance providers are doing liquidation while at least one could not get reinsurance.

No one can blame companies for the rash behavior, given the fluctuating market. Also, investors have second thoughts about investing in insurance companies in Florida. Fortunately, there are still companies that choose to stay and do exceptionally well. One of them is HCI Group, Inc. It continues to cushion and endure the harsh blows of the P&C insurance market. Roofing scams with unreasonable claims are tough challenges it faces. But, it continues to show its durability and resilience. For instance, its operating revenue reaches $126 million , a 33% year-over-year growth. Currently, its policies in force of 68,748 are 58% higher than in the comparative quarter. This is thanks to its flexible and strategic pricing and strong customer base and domestic presence. Its affordability and popularity keep its bond with its policyholders strong.

But of course, this substantial revenue growth does not translate into huge margins. Note that the 2021 hurricane season was among the most active in history. As such, its increased demand and premium prices went to cushion inflationary pressures. There has been an upsurge in applications for claims. Its loss and claims reserves amounted to $72 million, a 56% increase from 1Q 2021. The increase in claims is way higher than the increase in premiums written. Also, inflationary pressures are leading to higher expenses by 35%. Nevertheless. it remains profitable. It proves that its operational strategies and efficiencies are keeping its viability. So, the operating margin is still a positive value at 4% although it is way lower than in 1Q 2021.

If we compare it to its larger peers, HCI Group, Inc. appears to be doing better than most of them. It has one of the most durable core operations. It has the highest revenue growth and is one of the two companies with a positive operating margin. Also, it is the only one with an increase in policies in force. Given these observations, HCI has efficient strategies along with Universal Insurance Holdings, Inc. (UVE). Strategy and efficiency are more vital now amidst the challenges in the market. But, it may have to reconsider its upsurge in underwritings for safer operations.

Today, lawmakers are taking extra lengths to eliminate scams and abuses. In 2021, they approved a senate bill to provide an extra layer of protection for P&C insurance companies. So, contractors cannot talk with policyholders about P/C insurance roofing claim filings. The move must come from the policyholders. But, another challenge may arise because it prohibits insurers from denying claims for roofs less than fifteen years old. It is because the average useful life of a roof is twenty years. So, the possibility of scams is still present. Connivance may persist if the policyholders talk with contractors, especially when the roof age is near the limit. That is why lawmakers and companies may have to rethink their decisions since 79% of P/C insurance claims in the state face lawsuits. Most of them are fraudulent.

How HCI Group, Inc. May Stay Afloat In A Stormy Market Environment

The state of Florida has a stormy market landscape. It has more exposure to hurricanes and floods than many other states since it is along the coastline. Even worse, NOAA set above-normal storm expectations. There may be higher chances of property damages and more P/C claims. The geographic location and roofing scams are driving the threats of the P/C insurance crash. So, inflation and excessive claims must be managed to prevent the insurance exodus. Insurance businesses are now working on stabilizing their operations. HCI Group, Inc. must prepare itself for more challenges this year.

Thankfully, HCI has a stellar Balance Sheet with an excellent liquidity position. For instance, its cash and investments are high at $864 million, 12% higher than in 1Q 2021. Also, cash alone comprises more than 50% of the total assets so the company is very liquid. Cash and investments are more than enough to make a single payment for insurance liabilities and borrowings. Borrowings are lower than in the comparative time series, showing that it manages its financial leverage well. It is more crucial now, given the interest rate hikes. So even if net income becomes a negative value, it still has stable cash balances to sustain its operations.

The real estate hype may also help it drive more demand. A recent survey presented that 26 million Americans want to buy houses this year. It is about five times higher than the average sold units at 5-6 million annually. Despite external pressures, 34% of them are confident in their financial capacity. It is no wonder that the P/C insurance hype remains evident. Statistics also show a 3.7% and 6% CAGR in the global and US P/C insurance market. Being at the forefront of climate change, it remains a staple for many homeowners.

The expensive maintenance of houses and home belongings also makes P/C insurance more important. But, HCI Group, Inc. must be more cautious, given all the possible challenges. Stepping back a bit may help it make a sound judgment. Expanding in other states may also be a wise option although it may take time to increase its market presence. That is why it makes a sagacious move by enhancing its geographical diversification. Given all these, HCI may do better in the following years although growth may not be instant.

Stock Price Assessment

The stock price of HCI Group, Inc. has been moving sideways since the start of the year. It had a drastic decline in 4Q 2021, making its price low. At $65.97, it has already been cut by 20% from the starting price. Even so, the current stock price does not appear reasonable yet. Price ratios all point out to the potential overvaluation. It has the highest valuation, making it the most expensive stock among these Florida P&C insurance companies. Valuations aside, it still has the best fundamentals, making it a sensible stock to consider.

It also had a continued dividend payment with a dividend yield of 2.41%. Its average dividend growth in recent years is 6-7%. Plus, its percentage to FCF is low, so the company has adequate cash inflows to cover dividends. But again, the price may still be high to consider it a great buy now. We can assess the stock price using the discounted cash flow ("DCF") Model, EV/EBITDA, and the Dividend Discount Model.

DCF Model

FCFF $6,400,000

Cash $571,000,000

Borrowings $63,000,000

Perpetual Growth Rate 4.2%

WACC 9%

Common Shares Outstanding 10,126,000

Stock Price $65.97

Derived Value $62.71

EV/EBITDA

EV $187,180,000

Net Debt -$632,000,000

Common Shares Outstanding 10,126,000

Stock Price $65.97

Derived Value $62.41

Dividend Discount Model

Stock Price $65.97

Average Dividend Growth 0.06799677159

Estimated Dividends Per Share $1.6

Cost of Capital Equity 0.08965022013

Derived Value $59.24574252 or $59.25

All the stock price models adhere to the potential overvaluation of the stock price. There may be a 5-13% downside in the stock price. The stock price may still be high so investors may have to wait.

Bottom Line

HCI Group, Inc. may be in a still stormy market landscape, but it has proven its capacity to endure its blows. Its impressive market and financial position enable it to stay afloat and cover borrowings and dividends. Yet, the stock price is still higher than the ideal value. I am optimistic about its performance, but investors must wait for a better entry point. The recommendation is that HCI Group, Inc. is a hold.

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