KNSL - Kinsale Capital Group: Wait For A Correction

Summary

• Kinsale Capital Group operates in the field of E&S insurance, which generally involves more risk than ordinary insurance.
• The low combined ratio shows that the company has a good pricing policy and has costs well under control.
• The company must perform to deliver on the high valuation. Therefore, I wait for a correction before taking a stake in Kinsale Capital stock.

Introduction

Kinsale Capital's ( KNSL ) return over the past 6 years has been amazing, averaging 62% per year. This was due to strong growth in revenues and profits. Kinsale Capital continues to grow and many analysts expect strong growth to continue in the coming years.

Kinsale Capital operates in the specialty insurance business, offering property and casualty insurance products in all 50 states. Kinsale Capital was founded in 2009. Therefore it is a relatively young company but already very profitable. The company specializes in writing policies for hard-to-place property, casualty and special risks (excess and surplus lines), making this insurance company more sensitive to miscalculated risks than a regular insurance company. However, E&S insurance is less regulated than regular insurance and they therefore can charge higher premiums to mitigate the higher risk they take. Kinsale Capital is a well-run company that has proven its ability to grow strongly while being highly profitable.

Kinsale Capital Group's performance is excellent, and the outlook is also positive. The company pays a small dividend but is investing its cash to generate more income. However, the stock's valuation seems out of step in historical terms and compared to the general market.

Strong Earnings Growth And Excellent Combined Ratio

Kinsale Capital has grown strongly in recent years. Over the past 6 years, revenue grew an average of 34% per year and net income grew at an average of 35% per year. The share price increased even faster, averaging 62% per year. Thus, this indicates that the stock price has appreciated more expensively than at the time of the IPO.

One of the common metrics used to assess an insurer's operating profitability is the combined ratio. This metric is calculated by adding incurred losses and expenses and dividing by earned premiums. Kinsale Capital's combined ratio in 2022 was 77.9%, indicating that the company has its costs and incurred losses well under control. Overall, a combined ratio of 77.9% is an excellent performance. Markel (MKL) is also an E&S insurer, but has a combined ratio of 92% for the year 2022, which is also quite good.

Earnings in the fourth quarter were strong, with net income up 39.2% from the fourth quarter of 2021. Gross written premiums also increased strongly by 45% for the same period. Net investment income increased to $17.7 million in the fourth quarter of 2022 from $8.6 million in the same period last year. The high interest rate environment benefitted Kinsale Capital greatly. The Fed Funds Rate is expected to rise further to 5.5%, favoring net investment income.

Dividends And Share Repurchases

A closer look at dividends and share repurchases reveals that Kinsale Capital Group pays a small dividend per share of $0.56 (dividend yield of 0.17%). The company does not repurchase shares and can easily bear the dividend payout as it is only 8% of net income. Net income and free cash flow have increased significantly in recent years, with average annual growth in net income of 47%. The FCF statement for the fourth quarter of 2022 is not yet available, so the value in red in the table below represents the first through third quarters of 2022.

Stock Seems Expensively Valued

Kinsale Capital's growth has not stopped and many analysts expect strong growth in the coming years. Adjusted earnings per share of 22% is expected for 2023. For fiscal year 2024, 7 analysts expect earnings per share of $11.53, bringing the forward PE ratio to about 29, which is a fairly high number in this high interest rate environment.

However, a closer look at historical stock valuations shows that the PE ratio has always been high in recent years. In early 2022, there was a good buying opportunity when the PE ratio was around 25. But now, at a PE ratio of 46, things are looking expensive.

The 3-year average PE ratio is 40, and with a quick calculation by multiplying this figure by the expected earnings per share in 2024, the share price comes out to around $460 (45% undervalued). The question is whether this high valuation of the stock is reasonable in this climate of high interest rates. If earnings per share growth continues, yes, but right now the shares are priced for perfection.

Conclusion

Kinsale Capital Group operates in the field of E&S insurance, which generally involves more risk than ordinary insurance. Kinsale Capital has grown very well in recent years, which has also caused its share price to rise sharply. The low combined ratio shows that the company has a good pricing policy and has costs well under control. And the high interest rate environment has provided higher net investment income. The outlook for the next few years is also strong. However, Kinsale Capital carries more risk because E&S insurance is riskier than ordinary insurance. Moreover, the stock's valuation seems expensive compared to the general market and in historical terms. The company must perform to deliver on the high valuation. Therefore, I wait for a correction before taking a stake in Kinsale Capital.

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