2023-09-13 10:31:00 ET
Summary
- W. R. Berkley Corporation's valuation is high compared to the rest of the sector, making it an overpriced investment.
- The company's specialty insurance business and diverse portfolio have contributed to its impressive return on equity of 21.1%.
- WRB has managed to avoid volatility in the catastrophe insurance sector, leading to consistent earnings and a premium share price.
Introduction
I think that W. R. Berkley Corporation (WRB) has been awarded an almost growth stock valuation right now, especially when compared to the rest of the sector when it's trading at a p/e of over 13. Investors that seek an undervalued play may want to look elsewhere right now, as the premium I don't think is quite worth paying for, unfortunately. With insurance companies, I don't like paying too much for the book value, and right now WRB has a p/b over 2. My preferred range is between 0.8 (ideally) to around 1.2 at the higher end. That way, I am ensuring myself I am not overpaying for the asset base the company has collected. But the quality of WRB feels quite obvious right now, as the company has managed to achieve an ROE of 21.1% in the most recent quarter. That, in my opinion, is very impressive and if it's able to be maintained then perhaps a slight premium could be attached to the share price. For now, though, it's too high, and a hold rating will be my view on WRB.
Company Structure
WRB is primarily a specialty insurance business, focused on the excess and surplus (E&S) marketplace. Within its portfolio, WRB has meticulously curated a diverse array of over 50 distinct businesses, each entrusted to operate with a degree of autonomy. This approach empowers entrepreneurial management teams, driven by incentives, to achieve outstanding results within their specialized domains. So far the business has done very well for itself and managed to as I mentioned in the beginning reach a ROE of over 21%.
Overview (Investor Presentation)
One of the important characteristics of WRB is its investment strategy , which is notably attuned to the dynamics of the equity market. The company places a strategic emphasis on capitalizing on opportunities within the private equity market. This approach reflects WRB's commitment to seeking out investments that can generate substantial returns while also diversifying its financial holdings.
Volatility (Investor Presentation)
One of the impressive parts of the business right now I think is the capacity at which WRB has managed to avoid some volatility in the catastrophe insurance part. This part of an insurance business can often be associated with a lot of losses as unexpected events hurt the earnings potential of the business immensely. Historically, the company has managed to perform very well and outperform the industry by a large margin in the last several decades in terms of the volatility in market catastrophes. The ratio of event loss to surplus for the largest events has been lower than the industry as seen above on the chart. For example, During Covid, WRB had a ratio of 2.8% compared to the sector's 5%. This lower form of volatility and performance has likely added more to the valuation and is a reason for the premium associated with the share price today. Consistent earnings are rewarded very well in this market right now.
Looking at the results from the last report, we can see that WRB has been able to grow the premiums at a very solid rate, netting $3.3 billion in the last quarter. But what has me perhaps the most impressed is the growth of the ROE for the business. This has gone from 10.8% in Q2 FY2022 to 21.1% in Q2 FY2023. Historically, the 5-year average for the business has been 13.6%. So I think the premium attached to the share price right now is accounting for WRB being able to keep this ROE up for a significant time. A fall in it though could send the share price down I think quite quickly.
Looking closer at the asset base and financials of WRB, we can see that it holds most of it in corporate assets in the US. In terms of the cash the company has it sits at a solid 6% of the total assets. I think this is a great position to be in, as it should lend the company very much ability to continue making strategic investments and grow the portfolio. The vast majority of the asset base for WRB is held in fixed-maturity securities amounting to over $17 billion right now. Given the relatively low volatility of these, I think that WRB will be able to continue to deliver a strong ROA as a result.
Outlook
I think that WRB is in a decent position if the interest starts to decline eventually which I think will be somewhere in the second half of 2024 then the activity and deposits should start to increase as a result. If the interest rates are prolonged and stay elevated, it may suppress the deposit growth of WRB as a result. This would likely harm the share price in my opinion. In recent months though it seems to be regaining its trajectory upwards, and I think this can be maintained if WRB shows further deposit growth in the face of rising interest rates. As I still think the company looks expensive on a p/e basis, I will be sticking with my hold rating. From my point of view, though, it seems largely beneficial to stick with holding shares as we look for improvements in the bottom line before adding more.
On the valuation front though, as I said, WRB looks expensive on a p/e basis in comparison to the sector's med ian , exhibiting a near 30% premium on an FWD basis. A discount of around 15% I think is necessary before a buy case can be made, if not the EPS is shown to grow in the high double digits as WRB is expanding margins above expectations. Based on a p/b for the company it looks expensive as well as the premium is over 100% right now. In order for this to ever be justified, WRB needs to rapidly grow the deposits, which they aren't doing enough right now to make the valuation reasonable in my opinion.
Earnings Transcript
From the last earnings call the company held, the CFO of the business Richard Baio made some very good comments about their recent performance and also about how the market is looking right now for the company.
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"Net income doubled from the prior year quarter, resulting in $356 million or $1.30 per share. Annualized return on beginning of year equity was 21.1%, driven by strong underwriting and record investment income results. Operating return on equity was excellent at 18.4% and the heightened industry-wide catastrophe activity in the quarter enabled us to once again demonstrate our underwriting discipline in challenging environments. Simultaneously, our decision to maintain a short duration, high credit quality investment portfolio has enabled us to benefit from higher interest rates".
I think this comment highlights very well how the company has so far managed to deliver a strong return thanks to its operational performance and decision to take things more for the short term and be adaptable quickly, rather than staying put and not capitalizing on market conditions. With such strong retention and also growth in margins on some fronts, I can see why WRB has had its value reach a higher level like this.
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"Closing out the underwriting discussion with premium production. We increased gross premiums written by 9.3% to a record $3.3 billion and net premiums written increased 8.7% to a record $2.8 billion. All lines of business grew in the Insurance segment, with the exception of professional liability and workers' compensation, while property reinsurance grew in the Reinsurance & Monoline Excess segment".
With broad growth in this current market environment, I think it further solidifies the positive long-term prospects of the business. Broad segment expansion is proof that WRB is in a flexible position that can adapt quickly to new circumstances and manage to outperform the market regarding growing premiums.
Risk Associated
In an environment characterized by high interest rates, economic activity often experiences a slowdown due to the reduced spending capacity of the population. This, in turn, can have a cascading effect on various aspects of the economy, including the ability of individuals to save money. For a company like WRB, which operates in the financial sector, such economic conditions can pose challenges. So far it seems though that WRB has been able to grow its written premiums by a decent amount YoY. The gross premiums ended up at $3.3 billion, up from $3 billion 12 months earlier.
Capital Structure (Investor Presentation)
Looking at the company itself, the higher interest rates are causing them to have a higher interest expense to pay, which is hurting the bottom line of the business. WRB has over the years amounted to a debt position of $1.8 billion. Still down from almost 10 years ago though when it was $1.9 billion. For WRB, the interest expenses are at $127 million right now, and I don't think it will go down significantly in the short term as rates continue to stay elevated. What I am not that worried about though is the company's ability to pay this back. With an ROE of over 21%, WRB sits in a strong position to leverage its asset base and simultaneously return capital to shareholders through both buybacks and dividends.
Investor Takeaway
For investors that seek a solid insurance company, I think WRB is very interesting, but right now I find that the price one has to pay is too much. Without a better dividend yield, I don't think investors are getting enough incentivizes here to buy. The ROE is fantastic at 21.1%, but that doesn't negate the fact the p/e is 43% above the rest of the sector. I like the business model and the quality of it is on clear display, which is why I will have a hold rating for them right now at least.
For further details see:
W. R. Berkley Corporation: Strong ROE, Valuation Not So Much