2024-01-11 09:57:15 ET
Summary
- W. R. Berkley's strong underwriting practices and management of social inflation risks position it well in the insurance industry.
- The company has shown impressive financial performance, with growth in the top-line and bottom-line, and margin improvements.
- W. R. Berkley's proactive approach to addressing social inflation and favorable interest rate environment contribute to its future growth potential.
Thesis
W. R. Berkley's (WRB) core focus on strong underwriting practices and effective management of social inflation risks positions it as a strong player in the insurance industry. Together with its sensible financial management and favorable response to interest rate environments, the company stands well-appointed to navigate market challenges and sustain its growth trajectory.
Introduction
Let me introduce W. R. Berkley first. It is a company that is active in the financial services industry. It is known primarily for its work in the insurance industry. The company was founded a rather long time ago, in 1967. The company specializes in commercial insurance. W. R. Berkley offers quite a wide range of products and services. You might know them for property and casualty insurance products to businesses.
The company has an interesting business model as it uses decentralized operations. This allows individual units to operate somewhat independently while benefiting from the resources and financial strength of the larger corporation. This approach makes it possible to customize their services to specific niches. Furthermore, it makes them respond quickly to changes in the market.
Financial performance
Quarter Ended | 2023-09-30 | 2023-06-30 | 2023-03-31 | 2022-12-31 | 2022-09-30 |
Revenue | 3,031 | 2,996 | 2,895 | 3,014 | 2,724 |
Revenue Growth (YoY) | 11.24% | 19.22% | -0.70% | 16.89% | 12.38% |
Cost of Revenue | 1,636 | 1,570 | 1,539 | 1,522 | 1,565 |
Gross Profit | 1,394 | 1,426 | 1,356 | 1,492 | 1,160 |
Selling, General & Admin | 808.67 | 823.68 | 825.58 | 822.25 | 725.54 |
Operating Expenses | 942.61 | 937.22 | 948.34 | 981.38 | 841.78 |
Operating Income | 451.84 | 489.04 | 407.91 | 510.32 | 318.05 |
Other Expense / Income | -0.16 | -0.58 | 1.6 | -0.24 | 1.6 |
Net Income | 333.59 | 356.31 | 294.13 | 382.22 | 228.88 |
Gross Margin | 46.01% | 47.61% | 46.85% | 49.50% | 42.57% |
Operating Margin | 14.91% | 16.32% | 14.09% | 16.93% | 11.67% |
Profit Margin | 11.01% | 11.89% | 10.16% | 12.68% | 8.40% |
Source: Seeking Alpha (Retrieved on 01-09-2024). Financials in millions USD.
From the income statement, you can quickly observe that W. R. Berkley had great top-line and bottom-line growth in recent quarters, as well as margin improvements. I delved into the latest earnings call to find out the factors to this.
A lot of the performance improvement can be derived from great underwriting performance. This is indicated by a combined ratio of 90. The combined ratio is an important metric in the insurance industry. A combined ratio of 90 means that for every dollar earned in premiums, the company spends 90 cents on claims and expenses, leaving a 10-cent profit on each dollar before considering investment income.
A part of the underwriting performance can be linked to effective rate increases. The company successfully implemented rate increases, particularly in lines excluding workers' compensation. These increases offset rising costs and improve profitability. The rate increases refer to the premiums charged for their insurance policies. By adjusting these rates upwards, W. R. Berkley increases its revenue from policy sales.
Rates are based on trends observed by the company. One of those trends is the increasing challenge of social inflation, particularly in auto liability. Rates are determined by trends identified by the company. This includes the increasing challenge of social inflation, particularly in auto liability. As the company has noted and proactively managed the increasing costs of claims influenced by societal trends and litigation, it has effectively incorporated these observations into its rate adjustments.
You're perhaps not familiar with the term social inflation. Social inflation refers to the increasing costs of insurance claims that are not directly attributed to economic inflation but are driven by societal and legal factors. It's a concept in the insurance industry to describe how social trends and attitudes can lead to higher insurance costs.
Another factor for the positive performance is the huge boost in net investment income. This was mainly driven by a favorable interest rate environment (read: increasing interest rates).
The future
W. R. Berkley plans to continue changing its insurance premium rates based on trends that they think are important, especially in lines other than workers' compensation. This is a smart strategic response to the evolving market dynamics.
I believe the focus on social inflation is a must in today's society due to increasing litigation amount and increasing jury verdicts amount , which drive up claim costs.
By acknowledging and addressing social inflation, W. R. Berkley can adjust its insurance premium rates more accurately. This means pricing policies in a way that accounts for the increased risk and potential for higher claim payouts. Good-priced premiums help the company receive enough revenue to cover these increased costs. This helps improve profitability. Furthermore, understanding social inflation helps make for more informed underwriting decisions. It enables the company to identify and avoid excessively risky policies that are likely to result in high claims due to social inflation factors. Lastly, I believe that illustrating awareness and proactive management of social inflation could perhaps improve W. R. Berkley's reputation in the market. Such an increased reputation could attract more clients, increasing revenue.
This could help improve profitability further in the future, as it has done in the recent past.
Another huge factor in the future performance of the company is how the interest rates are going to move. As stated before, increasing interest rates will bring in more net income. However, the opposite is true as well of course. It's difficult to predict what will happen. Federal Reserve officials expect to cut the interest rate multiple times in 2024. This would have negative consequences for W. R. Berkley as its investment income would decrease. On the other hand, should interest rates stay higher for longer, an investment in W. R. Berkley would act nicely as an interest rate hedge in my view.
Challenges
One negative surprise in the future could be larger and quicker decreases in interest rates than anticipated. This would decrease (expected) future net income growth, decreasing the valuations for the company and thus the return of the stock.
Furthermore, another challenge is the rising medical costs in workers' compensation. The workers' compensation line of insurance is sensitive to the escalating costs of medical treatments and procedures. As healthcare becomes more expensive, the payouts required for medical claims increase. This is a significant challenge for W. R. Berkley, as it directly affects the cost of claims. When workers are injured, the insurance coverage must adequately compensate for their medical care, which is becoming increasingly costly.
Lastly, W. R. Berkley faces increasing competitiveness. This is especially true in Directors and Officers (D&O) insurance. The competitiveness in D&O insurance is partly driven by the evolving risks in the corporate world. You can think of regulatory changes, cyber threats, and other liabilities that company directors and officers must navigate.
Valuation
Metric | W. R. Berkley | Industry Median | S&P 500 median |
Trailing P/S | 1.57 | 1.22 | 2.72 |
Trailing P/E | 14.64 | 11.56 | 23.88 |
Gross Margin | 0.43 | 0.27 | 0.42 |
Quarterly Revenue Growth (YoY) | 0.11 | 0.5 | 0.07 |
Quarterly Earnings Growth (YoY) | 0.5 | 0.13 | 0.04 |
Source: Yahoo Finance. The industry medians are calculated with data available from 11 large market cap companies in the Insurance - Property & Casualty industry. Data is retrieved on 01-09-2024.
W. R. Berkley's trailing Price-to-Sales (P/S) ratio is 1.57, slightly above the industry median of 1.22. However, it is well below the S&P 500 median of 2.72. The trailing Price-to-Earnings (P/E) ratio at 14.64, while higher than the industry median of 11.56, is significantly below the S&P 500 median of 23.88. With a gross margin of 43%, W. R. Berkley outperforms both its industry median and the S&P 500 median. This shows efficient cost management and strong profitability in its operations.
The company's quarterly revenue growth at 11.24% year-over-year surpasses the S&P 500 median but is behind the industry median. Especially the growth of earnings is one of the primary selling points of this stock. As stated before in this article, W. R. Berkley knew not only how to drive revenue, but also operate much more efficiently. A part of the increase in income is caused by an increase in interest rates. But as a lot of companies in the insurance industry benefit from this, this is not the only reason for the difference in earnings between W. R. Berkley and the industry. In my opinion, it quite shows the managerial effectiveness of choosing rates and investing in the right opportunities. The advantage that many firms in the S&P 500 have is that they would benefit from interest rate decreases, contrary to W. R. Berkley. Nevertheless, due to continuing to invest in such opportunities, I do believe the income of W. R. Berkley should grow at double-digit rates again in 2024. Goldman expects the S&P 500 to increase roughly 5% in EPS in 2024.
I do think the premium on the industry is justified due to the managerial success in improving its income. Due to the, in my opinion, higher expected income growth combined with a much lower P/E ratio, I'd say W. R. Berkley is undervalued compared to the S&P 500. Because of this reason, I believe that the P/E ratio of W. R. Berkley should be near that of the S&P 500.
Conclusion
W. R. Berkley's strong financial performance, effective management of underwriting risks, and strategic rate adjustments provide a solid foundation for future growth. The company's proactive approach to addressing social inflation and leveraging favorable interest rate environments positions it well for continued profitability. There are challenges such as rising medical costs in workers' compensation and increased competition in the D&O insurance market. However, W. R. Berkley's robust operational framework and overall strategy and performance make me confident that they can deal with these challenges. The company's valuation metrics, when compared to industry and S&P 500 medians, suggest a slight undervaluation right now.
For further details see:
Strategic Agility In Insurance: W. R. Berkley's Path To Sustained Market Resilience