2023-04-12 11:35:14 ET
Summary
- Palomar is valued by the market at a discount to peers, even though it is a leading earthquake insurer which has delivered robust topline expansion in recent years.
- Due to rising reinsurance costs, PLMR's FY 2023 bottom line growth guidance wasn't as favorable as what I would have hoped for.
- My rating for Palomar is a Hold, as PLMR's valuation discount is justified by its meaningful exposure to higher reinsurance rates.
Elevator Pitch
I award a Hold investment rating to Palomar Holdings, Inc.'s ( PLMR ) stock. PLMR is trading at a lower forward P/E multiple than its peers now, despite the fact that Palomar's revenue growth outlook is better than most of the other specialty insurers. But I think that PLMR's valuations are fair, considering the headwind relating to higher reinsurance expenses. This explains why I have a Neutral view and Hold rating for Palomar.
Business Overview
As per the company's press release , Palomar describes itself as an "insurer serving residential and commercial clients in specialty markets."
The Main Types Of Insurance Products Offered By Palomar
PLMR revealed in its fiscal 2022 10-K filing that its key fronting, residential earthquake, commercial earthquake, and inland marine insurance products represented 25%, 24%, 15%, and 12% of its gross written premiums for the prior year. None of the other insurance product categories accounted for more than 6% of Palomar's FY 2022 gross written premiums.
In terms of geographic market exposure, California contributed 47% of Palomar's gross written premiums last year, with no other state having more than a 10% share of the company's 2022 gross written premiums.
PLMR Trades At A Discount To Peers Despite Superior Growth Profile
Palomar's expected pace of topline expansion for the fiscal 2022-2024 period is the second-fastest among its peers, as highlighted below, but PLMR's forward P/E multiple is the lowest in the peer group.
Peer Valuation Comparison For Palomar
Stock | Consensus Forward Next Twelve Months' Normalized P/E Valuation Metric | Consensus FY 2022-2024 Top Line CAGR Estimate |
Palomar | 17.2 | +19.4% |
AMERISAFE, Inc. ( AMSF ) | 17.5 | +2.4% |
ProAssurance Corporation ( PRA ) | 18.8 | +2.3% |
RLI Corp. ( RLI ) | 29.2 | -6.7% |
Kinsale Capital Group, Inc. ( KNSL ) | 32.3 | +25.0% |
Source: S&P Capital IQ
In its FY 2022 10-K filing, Palomar highlighted that it is the "4th largest earthquake insurer" in California, which is its key market accounting for 47% of its gross underwritten premiums for the previous year as mentioned above. The company is also ranked among the five largest players in the US earthquake insurance market.
At the Barclays' ( BCS ) Global Financial Services Conference on September 13, 2022, PLMR specifically mentioned about its approach revolving around the "identification of (product category and geographic market) niches in dislocated markets" to "attack." Palomar's growth strategy has worked well in the past as evidenced by its FY 2018-2022 revenue CAGR of +44.8%, and it is reasonable to assume that PLMR can sustain a strong topline growth trajectory in the near term.
But investors don't seem to have rewarded Palomar for its superior growth profile, as the market has valued PLMR at a discount to its peers based on the forward P/E valuation metric.
An Increase In Reinsurance Costs Is The Key Short-Term Headwind For Palomar
In the company's Q4 2022 earnings release issued earlier in mid-February this year, Palomar guided for an adjusted net profit of $88 million in FY 2023 as per the mid-point of its management guidance. This implies that PLMR expects its bottom line to expand by +23% for the current fiscal year, which seems like a reasonably decent net income growth rate at first glance. But Palomar's adjusted earnings actually rose by +36% from $52.4 million for FY 2021 to $71.3 million. In other words, PLMR's financial guidance points to a slower pace of bottom line expansion for the company this year.
At its Q4 2022 results briefing , PLMR noted that it "renewed our commercial earthquake quota share" with "the risk-adjusted pricing on these reinsurance buys" at "30% above the expiring terms." Palomar had also stressed at the most recent quarterly earnings call that it is comfortable with "the reinsurance assumptions that are in the guidance." The company's management comments imply that PLMR had incorporated the higher reinsurance costs into its FY 2023 earnings guidance, which implied a moderation in bottom line growth.
An earlier February 24, 2023 Seeking Alpha News article cited CFRA Research's forecasts that "reinsurance net written premiums" will potentially increase by +13%-18% this year following a +12%-15% growth last year. Notably, Palomar also highlighted at the company's Q4 2022 results call that it is "not going to make a call that the hard (reinsurance) market will end" in 2024, although it doesn't expect that "rate increases will be as pronounced." This means that reinsurance costs could potentially stay elevated for a longer-than-expected period of time.
In this unfavorable reinsurance cost environment, Palomar is likely to have been penalized by investors with a larger valuation discount for the company's shares due to its meaningful reliance on reinsurance. As disclosed in its FY 2022 10-K filing, Palomar's gross underwritten premiums amounted to $881.9 million in the prior year, of which a reasonably high 59% of the premiums were reinsured. In a nutshell, PLMR has significant exposure to high reinsurance rates, and this will be a drag on its near-term earnings.
Closing Thoughts
PLMR's shares are cheaper than its peers for a good reason, as the company has significant exposure to reinsurance rate increases, which has led to below-expectations earnings guidance for 2023. As such, I deem a Hold rating for Palomar to be fair and reasonable.
For further details see:
Palomar Holdings: Valuation Discount To Peers Is Justified