Stifel Nicolaus & Co. Analyst Meyer Shields says that he is generally skeptical of acquisitions in the insurance sector because the buyer typically acquires “every mistake that the selling firm has ever made.” But, he says ACE Limited’s (ACE) acquisitions tend to be more profitable than its competitors’.
“ACE actually has a phenomenally unique track record of identifying and executing on positive acquisition opportunities,” Shields says. “Those range from domestic opportunities, such as recently buying the high-net-worth personal lines business of the Fireman’s Fund from Allianz (ETR:ALV), to numerous international acquisitions in countries ranging from Mexico to Turkey to Indonesia and Malaysia.”
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Shields says the profitability of ACE’s acquisitions tends to work out very well.
“ACE doesn’t seem to experience the same reserve risk — where liabilities were understated by the acquired company — that has often played out merger and acquisition activity in the insurance industry,” he says.
FBR Capital Markets & Co., analyst Randy Binner says AFLAC Incorporated (AFL) has been “left for dead” by many investors because 75% of its business is focused on Japan and the yen has depreciated by about 50% versus the dollar over the last two years. But, Binner still recommends Aflac.
“I can’t help people with the yen piece, but we think that, through some reinsurance transactions, they are going to be able to hit buyback levels that are higher than the Street and that the sales of their products in Japan will continue to outperform,” Binner says.
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While Aflac is not as cheap on book value as Hartford (NYSE:HIG) or AIG (NYSE:AIG), Binner says it is trading at 10 to 11 times on earnings.
“Aflac is very profitable not only from what they can make on investment income, but also on their underwriting” he says. “It is a very predictable book of business.”
Among small-cap insurance stocks, FBR Capital Markets & Co., analyst Randy Binner’s top pick is National General Holdings Corp (NASDAQ:NGHC). He says the stock could see as much as 50% upside by 2017.
“We see both earnings and multiple expansion which, if you put together, could be another 50% upside in the stock over the next couple of years,” Binner says. “Now, we publish one-year price targets, so my one-year price target is $25, which will be 27% upside, but if I extended that thesis out to 2017 numbers, it would then go higher.”
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Binner says National General is trading at a discount to the peer group. While names like Progressive (NYSE:PGR), Allstate (NYSE:ALL), Infinity (NASDAQ:IPCC), Mercury (NYSE:MCY) generally trade around 14 or 15 times earnings, Binner says National General is trading at 11 times earnings.
“My belief is that that discount of the peer group is because it is not on people’s radars,” he says. “We have a lot of confidence that it will get a pure multiple on prior premiums some day, and so I get multiple expansion there that you just don’t find very often in a pretty mature industry.”
J. Robert Bredahl, President and Chief Operating Officer of Third Point Reinsurance Ltd (TPRE), says that the reinsurance market is at a cyclical low. But, while competitors are diversifying into primary insurance, he says Third Point is remaining independent.
“A lot of them have given up on the pure-play reinsurance model,” Bredahl says. “For us, given what we do on the asset side of our balance sheet, we get plenty of risk-taking diversification through Third Point, our investment manager, so there’s no compelling reason for us to diversify into the primary insurance business.”
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Bredahl, who previously worked for Aon, says he is not concerned about pricing pressure, even in a consolidating market. He says companies that are merging often “push this narrative” that it is better to be bigger in the reinsurance market. Bredahl disagrees.
“I think brokers and clients want more choices. When the market consolidates, we’re going to see more business,” he says. “We’re already seeing more business, despite there only having been a couple of mergers that have taken place.”
Among large-cap insurance companies, FBR Capital Markets Analyst Randy Binner says he is looking for “capital return stories” that have good cash generation to be returned to shareholders as buybacks and dividends. He says Hartford Financial Services Group Inc (HIG) fits that bill.
“In the case of Hartford, they are winding down an annuity business that has caused uncertainty in the stock,” Binner says. “We think they are doing a great job and are going to get a lot of cash out of there.”
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Binner says Hartford’s stock is inexpensive. It currently trades at right about its GAAP book value, he says, and has an attractive rate of capital return.
“If I was going to measure their total capital return as a percentage of market cap…Hartford is in the roughly 10% annual range,” Binner says. “These are our estimates over the next two years. So that’s a rate of capital return, which we define as buyback and dividends as a percentage of market cap. That’s much higher than banks or other insurance companies.”
Michael Ciarmoli, Analyst with KeyBanc Capital Markets, says he is looking for aerospace & defense stocks that have some internal catalyst that should enable them to grow — either management changes or new operating models. He says Triumph Group Inc (TGI) is one such company, and he currently has an “overweight” rating and a $77 price target on the stock.
“Triumph Group has been an underperforming aerostructure company, meaning they manufacture the large-scale components: wings, fuselages, tail sections,” Ciarmoli says.
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But, Ciarmoli says management changes at the executive level are likely to usher in positive changes for Triumph and its investors.
“There’s a significant opportunity at Triumph to unlock value,” Ciarmoli says. “Their CEO recently resigned, so someone new will be coming in, and I think fresh eyes on that operating model could be an opportunity for investors.”
Nick Heymann, Co-Group Head of global industrial infrastructure at William Blair & Company, is currently recommending stocks that have been able to avoid the oil and gas downturn and that have minimal foreign exchange headwinds. He says one such company is ADT Corp (ADT).
“They are in home automation with no oil and gas exposure and fairly nominal foreign exchange — about 11% of their sales are in Canada,” Heymann says. “So they have largely been able to dodge two of the biggest challenges facing most diversified industrials this year.”
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Heymann also likes ADT because the company is continuing to optimize the performance of its existing business model, which is based on its Pulse home automation installed security systems. ADT is on the cusp of growing its total user base sequentially and generating positive year-over-year free cash flow growth, which Heymann says are the last two key fundamental performance metrics to turn positive for the company.
“The company is well-positioned to be able to participate in what could be an exciting area for significant incremental free cash flow growth, and that’s the do-it-yourself monitored home automation space,” Heymann says. “This is a segment of the market today that represents about 78% of the North American security market, which so far has never been tapped.”
William Blair & Company Analyst Nick Heymann is currently recommending Graco Inc. (GGG). He says the company is presently achieving mid-single-digit organic growth.
“The company has gone through some adjustments related to oil and gas, which only accounts for about 3% to 4% of their sales. However, it does have a fairly significant impact from foreign currency exchange, and there has been slower demand for its products in some of its international markets, such as China, where the industrial economy has slowed,” Heymann says. “However, Graco is investing aggressively to expand its penetration in emerging markets, which is still only about 10% to 20% of its penetration levels here in North America. It’s also expanding its market share and penetration in developed overseas markets such as Europe and Japan.”
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Once a competitor starts using Graco’s products, they help improve productivity and lower costs so much that virtually any competitor must begin to utilize Graco’s products in order to remain cost competitive. Heymann says this tends to result in rapid increases in adoption rates of Graco’s fluid management products.
“After five or six quarters of significantly expanded market development expenditures, the company now appears to be on the cusp of expanding adoption and penetration in overseas developed and emerging markets. All this should spark stronger organic growth,” Heymann says. “So instead of 5% organic growth Graco achieved this last quarter, which was one of the highest in our space, it could soon move up to nearer upper-single-digit organic over the next few quarters.”
Nick Heymann, Analyst with William Blair & Co., says Rockwell Automation (ROK) had what he believes was the best fundamental performance in Q2 in the global industrial infrastructure sector. He attributes much of Rockwell’s success to Mexico.
“Rockwell is a company that enjoyed really strong representation across an extremely broad set of end markets and was able to, because of its broad geographic and end-market representation, report notably stronger performance even with the adverse impact from foreign currency and oil and gas and natural resources,” Heymann says. “However, Rockwell generated solid growth in many geographic regions and end markets it serves, even in South America, where they’re actually enjoying some of their strongest growth this year.”
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Heymann says Rockwell is seeing strong growth from its ability to help improve the efficiency of its customers’ existing mines, pulp and paper mills and smelting plants.
“This is in sharp contrast to new greenfield mines and plants, which are clearly more limited in number, particularly in South America currently,” Heymann says.
William Blair & Company Analyst Nick Heymann says many companies in the industrial sector are looking for acquisitions, but that that valuations in most industrial markets make them prohibitively expensive. However, one company that may be well-positioned to make a purchase is United Technologies Corporation (UTX), Heymann says.
“Evaluating all this portfolio change, United Technologies is likely going to spin out Sikorsky, and that should certainly free up some cash for them that may be used to fund further share repurchases and possibly also be used for acquisitions,” Heymann says.
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Using acquisitions to supplement flat to slight negative underlying organic growth is not a viable option for most industrial companies at this point, Heymann says. But, he says there are some other exceptions in addition to United Technologies.
“We do think that there are opportunities for certain companies to globalize their product base outside the U.S. where the penetration is low, like we mentioned with Graco or Wabtec,” Heymann says. “Dover certainly is seeing that with regards to their energy and refrigeration and food equipment businesses, as well as their engineered products and particularly their commercial printing business.”
