2023-08-09 18:15:05 ET
Summary
- Mercury General Corporation's share price has dropped nearly 25% in the last 12 months due to lackluster results and a poor margin profile.
- The company operates in the property and casualty insurance industry and has struggled to reach profitability since the US government lifted claims restrictions in 2020.
- MCY's net premiums written are increasing, but its negative ROE and growing combined ratio are concerning, making it a risky investment.
Introduction
Investors in Mercury General Corporation ( MCY ) are likely quite disappointed with the performance of the share price over the last 12 months, down nearly 25%. This seems to have come at the back of very lackluster results from the company and a margin profile that continues to disappoint and reflect the poor operations of the business.
The last couple of years have been harsh for MCY and the once shining light was in 2020 when the US government restricted claims and made the profitability of the company soar. Since then MCY has not been able to return to that and struggles to reach profitability. The combined ratio has grown from MCY to 110.1% from the last report. This is highlighting the fact that MCY is not a very solid insurance company based on fundamentals. It seems that the company is also funding the dividend from the cash position. Even though it's very large at over $4 billion, it seems there are better things that MCY could do right to make the company more appealing. I don’t like these practices and will be rating it a sell, unfortunately.
Company Structure
As mentioned previously, MCY operates in the insurance industry, more specifically the property and casualty insurance industry. Here it had a solid result in 2020 when there were restrictions to the number of claims people could perform. But after the restrictions were removed the loss ratio skyrocketed for MCY and it seems we returned to where the company should have been in reality.
Since then the bottom line has struggled and MCY is currently losing money each quarter consistently. In the insurance market, they focus on writing personal automobile insurance in the United States.
The company has a vast majority of its direct premiums coming from personal auto insurance but also a significant portion from homeowners too. MCY has developed a quite varied set of insurance offerings but this hasn't helped them reach any form of profitability, unfortunately.
The net premiums written are increasing though but not at the pace that makes the company able to reach strong ROE. It still sits at a negative 12.5% which is hurting the company immensely and I think investors should be quite concerned when seeing this margin. Historically MCY has had a positive ROE of 5.02% but the deterioration over the last couple of years is creating a dangerous investment.
Above we see the results from the last report of MCY which displays a growing combined ratio that reached 110.1% in the second quarter of 2023. The lackluster results seem to have impacted the share price too as it decreased a couple of percent following the release. Diving deeper into the report we see that the catastrophe losses grew for the company and it sat at $92 million for the quarter. This is a significant increase from Q2 of FY2022 which had it at $21 million instead. This increase seems to have been a leading cause for the growing combined ratio and I don’t particularly see any reason for it to go down in the near term either.
Fundamentals
As we have discussed already with MCY, the actual fundamentals are quite poor and this is making the continued dividend they stick to make even less sense. With a negative net margin, I think the focus should not be maintaining a shareholder-appealing dividend yield of over 4%. Previously MCY had a fantastic track record of growing the dividend, raising it for 35 years consequently but right now the challenge is to raise margins not maintain the dividend. They have a solid cash position of $4 billion and this will make them able to continue distributing it for another 28 years if they have the same amount as in 2022 which was $140 million. But this doesn't constitute what the management is doing right now as acceptable I think. As an investor, I would be concerned that the priorities are perhaps misplaced. Investing into expansions and securing market share seems more important instead.
Valuation & Comparison
Viewing the model above here it becomes quite obvious that reaching the required rate of return that I want is not possible at the current share price. The future dividend I don't think will quickly recover as the company should be focusing on raising margins rather than the dividend. As the GGM model comes out with that the target price is below what the price of today is it further bolsters my sell rating of the company I think.
Looking deeper at the valuation in comparison to the sector we have the p/b for example exerting a 12% premium to the sector, suggesting you aren't getting a good deal based on book value. With the poor margins, we also not getting a decent deal based on earnings since they are negative. Without a comparison, I think we are overpaying here based on fundamentals alone. Without fundamentals like profitability, you open yourself up to a lot of additional risks that are unnecessary to introduce in a portfolio.
Risk Associated
The persistent inflationary pressures are poised to exert further adverse effects on loss severity in the upcoming quarters. Despite the company's already-implemented price increases, the challenge remains that these adjustments may not fully counterbalance the escalating claim inflation.
The unfolding scenario underscores the complexities inherent in mitigating the impact of inflation on the company's operations. The interplay of various factors, including rising costs and potentially lagging adjustments, underscores the need for proactive strategies to cushion against the potentially erosive effect on financial metrics.
Moreover, the company's steadfast commitment to upholding its dividend-friendly reputation is a noteworthy aspect. While this aspiration is commendable, it's prudent to examine the context and necessity surrounding the dividend continuation. Dividend policies should be viewed through a lens of financial prudence and strategic alignment.
Investor Takeaway
The margins of MCY have been struggling and sit at quite disappointing levels right now. I don’t think the time to be investing in MCY is right now. The company is making some questionable decisions in my view like keeping the dividend even though margins are quite dismal. Don’t, expect a swift recovery in the dividend any time soon as MCY has other hurdles to tackle. The disappointing performance leads me to rate it a sell right now, unfortunately.
For further details see:
Mercury General Corporation - Not A Lot To Be Excited About