2023-09-03 10:40:00 ET
Summary
- RenaissanceRe's acquisition of Validus will make it the fifth-largest reinsurance company in the global P&C reinsurance market.
- The preferred shares of RenaissanceRe currently offer a yield of just over 6.4% and have strong dividend coverage.
- The acquisition of Validus will increase the common equity cushion for the preferred shares, making them safer.
Introduction
RenaissanceRe ( RNR ) is one of the world’s largest P&C reinsurers . It was the eighth-largest reinsurance companies based on the gross premiums written but the recent acquisition of Validus from American International Group ( AIG ) will catapult the combined entity to fifth place in the global P&C reinsurance market. Well behind Berkshire Hathaway, but definitely larger than SCOR and Everest Re.
In this article I would like to have a closer look at the preferred shares of RenaissanceRe. Those preferred shares are currently offering a yield of just over 6.4% and are quite attractive as the equity on the balance sheet has been bolstered by the recently-announced acquisition.
A quick look at the financial results to determine the preferred dividend coverage ratio
When I’m looking at preferred shares, I want to make sure the right boxes are ticked: I want to be sure the preferred dividends are easily covered by a company’s earnings and I want to make sure there's a "cushion" of common equity that ranks junior to the preferred shares and would absorb the first potential losses in case something goes wrong.
The preferred dividend coverage ratio can easily be figured out by looking at the income statement of a company.
During the second quarter of the year, RenaissanceRe reported a total of $2.65B in gross premiums written resulting in just under $2.2B in net premiums. And after subsequently deducting the almost $411M in unearned premiums, the total amount of net premiums earned increased to $1.79B. That’s an increase of about 22% compared to the second quarter of last year.
The total revenue came in at $1.85B. That’s almost $1B higher than in the second quarter of last year, but we shouldn’t read too much into this as this includes a net gain on investments and investment income of $70M compared to a $547M loss in the second quarter of last year.
It’s more important to also keep an eye on the operating expenses and it shouldn’t be a surprise to see the total amount of claims and expenses incurred increased as well, and the higher acquisition expenses should not come as a surprise either. This resulted in a pre-tax income of $381M and a net profit of $375M. Almost half of that net income was attributable to non-controlling interests which means just under $200M was attributable to RenaissanceRe of which $191M was attributable to the common shareholders . This resulted in a net income of $4.10 per share. Much lower than the $12.65 in the first quarter of this year but let’s not forget there was a $280M gain on the investments in the first quarter which was reversed in the second quarter.
What really matters from the perspective of a preferred shareholder is seeing the preferred dividends required the reinsurance company to pay less than 5% of its net income, despite including a $222.8M realized and unrealized loss on investments. That’s an excellent ratio and it indicates the preferred dividend payments are safe. And before you point toward the net loss (before taking the stake of non-controlling interests into consideration) of $267M and $664M in Q2 and H1 last year, keep in mind those results include a loss on investments of (respectively) $654M and $1.33B. So excluding those losses on the investment portfolio, RenaissanceRe would for sure have been profitable. And sure, a loss always has to be taken into account and simply ignoring it would be a bad idea, but it isn’t a real deterrent from the perspective of Renaissance’s ability to cover the preferred dividend payments.
And looking at the balance sheet (above), we see the total equity attributable to RenaissanceRe is approximately $7.4B. With just $750M in preferred equity, there's a "cushion" of about $6.65B in common equity and the ratio of common equity to preferred equity is almost 900%.
So from both the dividend coverage perspective as well as the asset coverage level, the preferred shares of RenaissanceRe appear to be pretty strong.
The details of the preferred shares
As explained in my previous article on the preferred shares of RenaissanceRe:
There are currently two series of preferred shares outstanding, and both issues are non-cumulative in nature. The F-shares ( RNR.PR.F ) have a 5.75% preferred dividend yield and are callable since June . The G shares ( RNR.PR.G ) have a lower dividend yield of 4.20% ($1.05 per share per year paid in four quarterly installments) and can be called from July 2026 on at par but can be called before if a regulatory capital event occurs (at no premium) or if a rating agency event occurs (at a 2% premium). The latter would kick in if the rating agencies lower Renaissance’s credit rating. For the purpose of this article, I will assume both series of the preferred shares won't be called.
The current share price of the Series G is just $16.40. This means the yield has increased to 6.4% based on the current share price. Additionally, the F-Series is currently trading at around $22.17, resulting in a yield of 6.48%. As a reminder: Those shares can currently be called but the market obviously doesn’t think this is likely as the preferred stock is trading in excess of 10% below the call price of $25/share).
Investment thesis
While the situation at the end of June appears to be very favorable for the preferred shareholders, let’s not forget the company is currently acquiring Validus Reinsurance from AIG. The price tag for the acquisition is just under $3B of which $2.74B will be payable in cash and $250M will be payable in common shares. RenaissanceRe already raised about $1.35B in a capital raise during the second quarter (this is already reflected in the total equity on the balance sheet), and on top of that, it issued $750M of 5.75% senior notes (with net proceeds of just under $742M) so the financing of this acquisition should not be a problem. RNR expects to close the acquisition in the final quarter of this year, and this deal has generally been well received by Wall Street as RenaissanceRe expects the deal to be immediately accretive to the book value per share and the Return on Equity .
The fact RenaissanceRe raised almost $1.5B in equity for this deal actually makes the preferred shares safer as the "common equity cushion" has increased pretty substantially compared to the end of 2022 on the back of the capital raise and the retained earnings (Renaissance pays a pretty low dividend of $0.38/share on its common shares).
I currently have no position in the preferred shares of RenaissanceRe but I'm watching with interest as I think the risk/reward ratio is pretty attractive now (although the "reward" portion is relatively low on the spectrum with a preferred dividend yield of just 6.4%).
For further details see:
RenaissanceRe: The 6.4-6.5% Yielding Preferred Shares Are Still Appealing