Whopper is a deep value investor and the founder of whopperinvestments.com. He can be reached at [email protected]
Currently trading for 70% of tangible book despite a history of consistent profitability and relatively strong ROE, Investors Title Company (ITIC) is a potentially significantly undervalued insurance company.
I first stumbled upon ITIC from when it was posted on the rational walk (see here for the initial write up andhere for a quick follow up on some potentially hidden assets that could (slightly) increase value). Insurance is much more his forte than mine, so I encourage you to read his write ups. This post is very much my attempt at starting to get familiar with the insurance industry and valuing insurance companies by writing up a company that I think has interesting value characteristics, so take everything with a grain of salt.
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Anyway, ITIC sells title insurance. The are a bit player in this industry, which is dominated by four large players. Most (between 40-50%) of their business comes from North Carolina. I like this for a couple of reasons- 1) NC was not one of the “centers” of the housing bubble like California, Florida, etc, so while business is down in the recession, it hasn’t been absolutely crushed and should recover to normal levels as the economy continues to recover. 2) it gives them something of a niche in that they should know the market and be able to price/understand the risks in it better than the giant players.
As you might expect, business has been hard hit by the recession and housing crisis. Title insurance is only purchased when a property is sold or refinanced, and the drop off in sales led to a drop off in demand for title insurance. Still, the company weathered the crisis pretty well, reporting a loss only in 2008 and easily weathering the recession due to a near fortress balance sheet.
On to valuation. The company currently trades for a market cap of ~$72m ($31.5 per share) despite a book value of just shy of $104m (just over $45.5 per share). Given most insurance companies trade for at least tangible book (and sometimes a multiple of it), that alone makes them interesting. What I think makes them really interesting though, is their earnings power. Currently, with the low volumes from the recession, the company is earning ~8% margins on their underwriting business. This makes them pretty interesting for a couple of reasons. First, as an insurance company, they get paid premiums upfront and get to invest the float while waiting to pay claims. They pay out between 15-20% of reserves in claims each year, so they get an average of about 3 years worth of free float every time they take in a premium. In a high interest/inflationary environment (not saying that’s coming, but always a concern with Q.E.3,4,5, and 6 on the horizon), that float would be incredibly valuable. Even in today’s low interest rate environment, that’s pretty valuable. Some insurers write insurance at a loss just to get float to invest, so to do it at a decent profit, especially in a sluggish environment, is pretty impressive.
But are ~8% margins sustainable? I say no…. their likely much too low given the company’s past. Pre-housing crisis, the company was underwriting at 15%+ margins, and they were underwriting at ~12-13% margins before the housing bubble started getting really frothy. Even if revenue doesn’t recover from today’s volume, if they could get back to 13% margins, that would add another $3m or so in earnings power to this company. It’s hard to see margins recovering that fully given the fixed costs involved in operating the business, but I think projecting margins of 12% on 10% higher revenue as the company’s mid-cycle earnings power is pretty reasonable, given that’s what they were doing in 2002. That would give the insurance operations pretax earnings power of about $8m per year. Subtract out $3-4m per year in overhead, and the company could very easily make $5m per year from insurance operations alone (remember, the insurance operations generates float- no cost money that can be invested while waiting to pay it out, so that $5m is a good bit more valuable than $5m from a manufacturing business, where you need to invest capital in order to get that profit).
Then there’s the investment portfolio. At year end, the company had ~$100m in bonds and $30m invested in stocks (plus about $9m in cash and accrued interest). The bonds are invested ~12% in long term (10+ year to maturity) bonds, with the remainder split pretty evenly between 1-5 year and 5-10 year maturity bonds. They earned $3.4m in interest on them last year and the year before, so I think it’s safe to assume they will earn that rate going forward. Some of the bond state invested in tax advantaged local bonds, so they could likely earn a bit mroe by switching over to treauries, but I’ll use $3.4m as the pretax return from their bonds. On the $30m of equity, I don’t claim to be a forecaster of stock prices, but going forward I think a 5% rate of return for stocks would be reasonable. That would be an additional $1.5m in earnings. Let’s make the math easy and say their investment portfolio will generate $5m in pretax income going forward.
So, using my projections, I get earnings power going forward of $10m pretax. Given they earned more than this in every year from 2002-2007 (pretax earnings ranged from $11.6m-18.6m, with four of the six years coming in over $15m), I think that’s a pretty conservative number.
With a market cap of $72.5m and ~$9m in net cash, they would trade for around 7x my projection of pretax earnings. That’s cheap. Add in the fact the ROE was consistently between 15-18% pre-crisis (despite a maybe too conservative balance sheet) and management’s history of share buybacks, dividends, and maintaining a fortress balance sheet, and I think that’s too cheap. Readers who consider the insurance industry within their circle of competence should certainly take a look at this one. I personally don’t, but as I continue to gain experience in the area/read the 10-Ks and value other insurers, I will be revisiting this company and could see myself making an investment in them at some point.
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