Tag Archives: special dividend

Lancashire finds the love

After going ex-dividend in November, investors went mega bearish on Lancashire (LRE.L) when it nearly dropped below the 500p level, as the graph below shows. A previous post highlighted the reasons behind the change in sentiment over the first half of 2014 on the once darling of the specialty insurance sector.

click to enlargeLancashire Insurance Group 2014 Share Price

The firm released its Q4 today and announced another special dividend of $0.50 on top of the regular $0.10 dividend. Driven by stable results, as per the graph below, and by the chatter that Lancashire could be an M&A target, the price today reflects a respectable 160% multiple to diluted tangible book. It was odd that although the firm’s executives joked about having prepared an answer to the M&A question, no analyst actually asked the question in the conference call today!

click to enlargeLancashire Historical Combined Loss 2008 to 2014

One of the big positives from the call today was the news that the firm has restructured their reinsurance programme that protects their book to give them more event coverage with reinstatements (away from previous aggregate cover). This provides more protection to Lancashire from multiple events. The PMLs as at January expressed as a percentage of the calendar year earned premiums (estimated figures for 2015) show the reduced net risk profile of this arbitrage strategy.

click to enlargeLancashire PMLs January 2015

It’s nice to see Lancashire recover some of its shine and it will be intriguing to see if it does become an M&A target in the coming months.

Lancashire is looking unloved

With exposure adjusted rates in the specialty insurance and reinsurance sector continually under pressure and founder/former CEO, Richard Brindle, making an unseemly quick exit with a generous pay-out, Lancashire’s stock has been decidedly unloved with the price trading well below the key £7 threshold highlighted in my last post on the subject in February. Although we remain in the middle of the US hurricane season (and indeed the Napa earthquake is a reminder that its always earthquake season), I thought it was a good time to have a quick look over Lancashire’s figures again, particularly as the share price broke below the £6 threshold earlier this month, a level not seen since early 2011. The stock has clearly now lost its premium valuation compared to others in the London market as the graph below shows.

click to enlargeLondon Market Specialty Insurers Tangible Book Value Multiples August 2014

Results for H1-2014, which include full numbers from the November 2013 acquisition of Cathedral, show a continuing trend on the impact of rate reductions on loss ratios, as per the graph below.

click to enlargeLancashire Historical Combined Loss 2006 to H12014

The impact of the Cathedral deal on reserve levels are highlighted below. The graph illustrates the consistent relative level of IBNR to case reserves compared to the recent past which suggests a limited potential for any cushion for loss ratios from prior year reserve releases.

click to enlargeLancashire Historical Net Loss Reserves

The management at Lancashire have clearly stated their strategy of maintaining their discipline whilst taking advantage of arbitrage opportunities “that allow us to maintain our core insurance and reinsurance portfolios, whilst significantly reducing net exposures and enhancing risk adjusted returns”. In my last post, I looked at post Cathedral gross and net PMLs as a percentage of earned premiums against historical PMLs. More applicable figures as per July for each year, against calendar year gross and net earned premiums (with an estimate for 2014), are presented below. They clearly show that the net exposures have reduced from the 2012 peak. It is important to note however that the Gulf of Mexico net 1 in 100 figures are high at 35%, particularly compared to many of its peers.

click to enlargeLancashire PMLs July 2010 to July 2014

There is of course always the allure of the special dividend. Lancashire has indicated that in the absence of attractive business opportunities they will look at returning most, if not all, of their 2014 earnings to shareholders. Assuming the remainder of 2014 is relatively catastrophe free; Lancashire is on track to make $1-$1.10 of EPS for the full year. If they do return, say, $1 to shareholders that represents a return of just below 10% on today’s share price of £6.18. Not bad in today’s environment! There may be a short term trade there in October after the hurricane season to take advantage of a share pick-up in advance of any special dividend.

Others in the sector are also holding out the prospect of special dividends to reward patient shareholders. The fact that other firms, some with more diverse businesses and less risky risk profiles, offer potential upside through special dividends may also explain why Lancashire has lost its premium tangible book multiple, as per the first graph in this post.

Notwithstanding that previously Lancashire was a favorite of mine due to its nimble and focused approach, I cannot get past the fact that the sector as a whole is mired in an inadequate risk adjusted premia environment (the impact of which I highlighted in a previous post). In the absence of any sector wide catalyst to change the current market dynamic, my opinion is that it is expedient to pass on Lancashire here, even at this multi-year low.

The game of chicken that is unfolding across this sector is best viewed from the side-lines in my view.

Smart money heading for the exits?

Private equity is rushing to the exits in London with such sterling businesses as Poundland and Pets at Home coming to the market. PE has exited insurance investments, following the successful DirectLine float, for names like Esure, Just Retirement, and Partnership. It was therefore interesting to see Apollo and CVC refloat 25% of BRIT Insurance last week after taking them off the market just 3 short years ago.

The private equity guys made out pretty good. They bought BRIT in 2011 for £890 million, restructured the business & sold the UK retail business and other renewal rights, took £550 million of dividends, and have now floating 25% of the business at a value of £960 million. To give them their due, they are now committing to a 6 month lock-up and BRIT have indicated a shareholder friendly dividend of £75 million plus a special dividend if results in 2014 are good.

I don’t really know BRIT that well since they have been given the once over by Apollo/CVC. Their portfolio looks like fairly standard Lloyds of London business. Although they highlight that they lead 50% of their business, I suspect that BRIT will come under pressure as the trend towards the bigger established London insurers continues. Below is a graph of the tangible book value multiples, based off today’s price, against the average three year calendar year combined ratio.

click to enlargeLondon Specialty Insurers NTA multiples March 2014

Lancashire’s recent lackluster share performance

Lancashire (LRE.L) is a London quoted specialty insurer that writes short tail (mainly insurance) business in aviation, marine, energy, property catastrophe and terrorism classes. Set up after Hurricane Katrina, the company operates a high risk high reward business model, tightly focussed by the experienced hand of CEO Richard Brindle, with an emphasis on disciplined underwriting, tight capital management and generous shareholder returns. Shareholder’s equity is managed within a range between $1 billion and $1.5 billion with numerous shareholder friendly actions such as special dividends resulting in a cumulative shareholder return of 177% since the company’s inception over 7 years ago.

I am a fan of the company and own some shares, although not as many as in the past. I like their straight forward approach and their difference in a sector full of firms that seem to read from each other’s scripts (increasingly peppered with the latest risk management speak). That said, it does have a higher risk profile than many of its peers, as a previous post on PMLs illustrated. That profile allows it to achieve such superior shareholder returns. The market has rewarded Lancashire with a premium valuation based upon the high returns achieved over its short history as a March post on valuations showed.

However, over the past 6 months, Lancashire’s share price has underperformed against its peers, initially due to concerns over property catastrophe pricing pressures and more recently it’s announcement of the purchase of Lloyds of London based Cathedral Capital.

click to enlargeLondon Market Specialty Insurers Share Price 2012 to August 2013

Cathedral’s results over the past 5 years have been good, if not in the same league as Lancashire’s, and the price paid by Lancashire at 160% of net tangible assets is not cheap. Given the financing needs of the acquisition, the lack of room for any of Lancashire’s usual special dividend treats in the near term has been a contributing factor to the recent share price declines in my opinion.

Based upon the proforma net tangible assets of Lancashire at end Q2 as per the Cathedral presentation and the circular for the share offering, the graph below shows the net tangible valuation multiples of a number of the London market insurers using net tangible asset values as at end Q2 with market values based upon todays’ closing prices.

click to enlargeLondon Market Specialty Insurers Net Tangible Book Multiples August 2013

The multiples show that the market is now valuing Lancashire’s business at a level more akin to its peers rather than the premium valuation it previously enjoyed. Clearly, the acquisition of Cathedral raises questions over whether Lancashire will maintain its uniqueness in the future. That is certainly a concern. Also, integrating the firms and their cultures is an execution risk and heading into the peak of the US wind session could prove to be unwise timing.

Notwithstanding these issues, Brindle is an experienced operator and I would suspect that he is taking full advantage of the current arbitrage opportunities (as outlined in another post). It may take a quarter or two to fully understand the impact of the Cathedral acquisition on Lancashire’s risk/reward profile. I, for one, look forward to stalking the company to find an attractive entry point for increasing my position in anticipation of the return of Lancashire’s premium multiple.