RLI - RLI Corp.: A Dividend Aristocrat Priced For Perfection

2023-08-07 12:13:59 ET

Summary

• RLI Corp. is part of the esteemed "Dividend Insurance Champion" club and has consistently increased its dividend for the past 48 years.
• RLI has a strong track record of steady underwriting results, with a combined ratio below 100 for the past 27 years.
• The company declares consistent cash dividends and annual special dividends, but its current valuation is considered overvalued.

Executive Summary

RLI Corp. ( RLI ) is part of the esteemed "Dividend Insurance Champion" club, alongside Aflac ( AFL ), Chubb ( CB ), Cincinnati Financial ( CINF ), and Old Republic ( ORI ).

Despite its low dividend yield (below 1%), RLI is highly regarded by investors for consistently increasing its dividend for the past 48 years. Additionally, the stock has outperformed the S&P 500 in terms of total return over the last two decades.

However, last year's exceptional performance was influenced by the sale of minority interests in Maui Jim. While RLI's past stock performance has been impressive, replicating the same results might be challenging.

In 2023, the stock has generated a total return of approximately 4%, which is significantly lower than the S&P index's total return of nearly 17.8%.

However, it overperformed the S&P P&C Insurance, which showed a negative return of 2.8%.

The fact that RLI has outperformed the insurance industry index indicates that the company has demonstrated its resilience to both analysts and investors.

The recently released quarterly results once again showcased the company's strong position in the U.S. property and casualty market. Year-to-date income increased by circa $130 million compared to the previous year.

However, the substantial increase in year-to-date earnings was primarily driven by unrealized equity gains recorded during the year.

Additionally, the investment income also experienced growth, rising by $20 million to $53 million compared to the previous year.

Despite the resilience of the underwriting margins and the growth in investment income, driven by an increase in investment yield, the current valuation of 4.6 times the book value implies that the stock is priced for perfection.

Steady Underwriting Results

RLI has proven to be a resilient and outperforming insurer, offering property, casualty, and surety insurance coverages. Over the last 27 years, RLI has maintained a combined ratio below 100, surpassing the industry average by an average of 12 points over the past decade.

During the first six months of the year, RLI recorded an underwriting income of $109 million, resulting in a combined ratio of 82.7%.

The surety and property businesses has been significant contributors to this steady underwriting gain, consistently delivering a low double-digit combined ratio (respectively 75.8% and 71.5%). The casualty business suffered from an increased level of storm losses, a reduced impact of favorable prior years’ reserve development. Storm losses totaled $18 million in the quarter, a $17 million impact in property and $1 million casualty.

Despite facing inflationary pressures, which led to a year-over-year increase in the loss ratio for all segments, RLI is still well-positioned to achieve steady underwriting results for 2023.

Consistent Cash Dividends Paired With Annual Special Dividends

The company is recognized as one of the dividend aristocrats due to its long track record of dividend increases, and it also declares annual special dividends to redistribute capital excess to shareholders.

In 2022, the company distributed a special dividend of $7.0 per share, which was made possible by the sale of its minority interest in Maui Jim.

In 2023, without any exceptional effects like those in 2022, the special dividend is expected to be lower, ranging from $1.0 to $2.0 per share.

However, this special dividend will still be covered by the consistent underwriting gains and recurring investment income, which have been positively influenced by the higher investment yield observed since the beginning of 2023.

Valuation

RLI's current valuation stands at 4.5 times the book value, whereas its peers' stocks are traded at a multiple ranging from 1.5 to 2.5. The drivers behind this high valuation are attributed to several factors:

• A best-in-class combined ratio within the property and casualty insurance industry. Over the past decade, the combined ratio has consistently remained below 96.4%, with a 10-year average of 88.8%.
• Consistent dividend increases for the last 48 consecutive years.
• A positive perception of the company among investors, viewing RLI as a SWAN (Sleep Well At Night) stock.

Despite its impressive financial performance, I consider RLI's valuation to be "priced for perfection", with no safety margin.

Final Thoughts

Although RLI is a highly profitable and well-managed insurance company, the current valuation appears too high. The company seems to be priced for perfection, leaving it vulnerable to any decline in earnings or market uncertainties.

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