2023-07-04 04:38:55 ET
Summary
- The California Earthquake Authority's difficulties could provide opportunities for Palomar Holdings' core earthquake insurance business to gain market share.
- PLMR has plans in place to grow its relatively new casualty insurance business, which will aid diversification efforts.
- Palomar Holdings' new FY 2023 earnings guidance is above the current analysts' consensus bottom line estimate, so there is a chance for PLMR to report earnings beats in subsequent quarters.
- I upgrade my investment rating on Palomar Holdings to a Buy, in consideration of multiple re-rating catalysts that I have identified.
Elevator Pitch
I raise my rating for Palomar Holdings, Inc. ( PLMR ) shares from a Hold to a Buy. I previously discussed about PLMR's FY 2023 earnings guidance and the stock's valuations in my April 12, 2023 initiation article .
The multiple catalysts for PLMR include market share gains for the company's earthquake insurance business, a more diversified business profile driven by the growth of its casualty insurance unit, and potential positive earnings surprises. Taking into account the key catalysts for the stock, I am of the view that a Buy rating for Palomar Holdings is warranted.
California Earthquake Authority's Recent Developments Are Positive For PLMR
A June 2, 2023 S&P Global Market Intelligence article highlighted "reports that the California Earthquake Authority was having trouble placing its reinsurance." Earlier in December last year, industry publication Reinsurance News mentioned that the California Earthquake Authority could be "forced to reduce its reinsurance program", as it is "struggling to secure ample capacity at renewals."
Palomar Holdings noted at the company's Q1 2023 results call in May that the aggregate reinsurance limit for the California Earthquake Authority decreased by around $1.4 billion between December 2022 and April 2023. With my April 2023 initiation article, I specifically emphasized that PLMR is among the five biggest earthquake insurance player in California, and indicated that close to half of Palomar Holdings' premiums are generated from California. This suggests that recent developments relating to the California Earthquake Authority have a significant impact on PLMR.
At its first quarter earnings briefing, Palomar Holdings disclosed that it is a "beneficiary of freed up supply of earthquake reinsurance capacity", and revealed that PLMR is perceived to be a "stronger option" due to its status as "a rated participant in the earthquake market." This implies that PLMR's core earthquake insurance business is in a very good position to gain share in the California earthquake insurance market at the expense of the California Earthquake Authority.
Efforts To Grow Casualty Insurance Business Could Reduce Concentration Risks
In the preceding section, I outlined how Palomar Holdings' earthquake insurance business could potentially benefit from recent developments at the California Earthquake Authority. But it is also a fact that PLMR's earthquake insurance business poses a certain degree of concentration risks. As mentioned in my April 12, 2023 write-up, commercial and residential earthquake insurance in aggregate accounted for about 39% of Palomar Holdings' FY 2022 gross written premiums.
As such, it is encouraging to see signs of PLMR putting in plans to grow its other businesses like casualty insurance.
Palomar Holdings indicated at its first quarter results briefing that the company's casualty insurance business was one of the few areas in the company which had new "key hires." Apart from the casualty insurance business unit, PLMR only added to its ranks significantly in other back-office units such as "data analytics and actuarial." This sends a clear signal that the casualty insurance business is a key growth priority for PLMR.
It is also noteworthy that the casualty insurance unit for Palomar Holdings was only first established in 2021 as indicated at the company's Investor Day last year. Given that the casualty insurance unit is a relatively new business for PLMR, there is lots of room for Palomar Holdings to expand this casualty insurance business and diversify the business mix for the company as a whole.
Short-Term Financial Outlook For Palomar Has Become More Favorable
With my prior April 2023 article, I highlighted that Palomar Holdings' initial fiscal 2023 normalized net income guidance in the $86-$90 million range was disappointing. This translated into a significant moderation in PLMR's earnings growth from +36% in FY 2022 to +23% for FY 2023 based on the mid-point of the company's guidance.
At the end of May this year, PLMR announced that the company has revised its FY 2023 adjusted earnings guidance upwards to between $88 million and $92 million, which is equivalent to a superior +26% bottom line expansion for the current fiscal year as per the mid-point of guidance. Palomar Holdings has considered the company's year-to-date financial performance and the renewal of certain reinsurance programs in making the decision to lift its full-year bottom line guidance.
However, there is a mismatch between Palomar Holdings' favorable outlook and the market's expectations. Based on the consensus financial numbers taken from S&P Capital IQ , the current sell-side consensus FY 2023 normalized net profit forecast for PLMR is $83.1 million, which is about -8% below the mid-point of the company's updated earnings guidance at $90 million. I think this opens up an opportunity for Palomar Holdings to deliver positive earnings surprises in the quarters ahead.
Concluding Thoughts
Palomar Holdings is now valued by the market at a consensus forward next twelve months' normalized P/E multiple of 16.9 times (source: S&P Capital IQ ), and this is significantly below PLMR's three-year average forward P/E ratio of 29.9 times. I award a Buy rating to Palomar Holdings on the basis that there are visible catalysts in place which could help to re-rate PLMR's price and valuations.
For further details see:
Palomar Holdings: Multiple Catalysts (Rating Upgrade)