Thursday, July 10, 2008

White Mountains Insurance (WTM)

My posts the next few weeks will focus on what I consider to be attractive names in the Financial Sector. While this may not seem like a good time to buy Financial Stocks, one of the most important principles of Value Investing is using periods of panicked and indiscriminate selling in the market to establish positions in names that are still viable and will survive the current real and imagined hysteria in the market.

The first company I want to discuss is White Mountains Insurance (WTM).

WTM is a property casualty insurance company with three main segments:

One Beacon - WTM owns 75% of One Beacon Insurance Group, a publicly traded specialty insurance company that trades under the symbol OB.

Esurance - A personal lines insurer selling auto insurance in 28 states.

White Mountains Re - A multi-line reinsurance company.

White Mountains Insurance has sold off with the rest of the Financial Sector, and has gone from over $600 per share down to the $420-430 range in less than a year.



Although it would expedient for me as an investor to blame the "market" for the decline in WTM stock, this would be intellectually dishonest, as the company is facing several other issues, some real and some imagined, but all of which share part of the blame for the decline:

1) WTM is facing some serious reserve issues in its White Mountains Re America business, involving insurance that it underwrote years ago to cover construction defects in California. The company provided great detail about this at its analyst meeting in June, and swears that the issue is now behind them. The latest reserve addition announced was $140 million to cover these claims, offset partially by a reserve release at another subsidiary of the company.

2) The property and casualty insurance industry, in general, is entering what is known as a "soft market." What this means is that pricing for many lines of insurance is declining, and getting and renewing that business is becoming harder to do as the industry becomes more competitive.

3) Warren Buffett, a long time and major shareholder of WTM, recently negotiated an agreement with WTM to sell his entire stake back to the company. This spooked many investors who subscribe to the cult of "smart money."

So given all this, why do I like WTM.

WTM has a long term track record of growing tangible book value per share. While many investors look at earnings, I tend to look at growth of tangible book value for insurers, since earnings are so easy to manipulate. Since its IPO in 1985, WTM has increased tangible book value at an average annual rate of 17%.

As the market becomes soft, it is important for an insurer to maintain underwriting discipline, or the ability and inclination to price insurance rationally and profitably, so that reserve issues don't emerge later on. While many insurers talk this up, I believe that WTM is committed to this. This can be seen in the declines in premium growth in many of its lines as they walk away from business rather than meet irrational pricing by its competitors. Although the recent reserve issues concern me, I am confident that management has gotten a handle on the issue.

The investing track record of WTM is excellent. Insurers make money two ways: they make an underwriting profit and they take the premiums they receive and invest them while they wait for claims to be paid. WTM earned a return of 8.3% on its investment portfolio in 2007, and 0.8% in the first quarter of 2008.

WTM is trading at the bottom of its historical price to tangible book value trading range. The last reported tangible book value was $443 a share at 3/31/2008, giving us a price to tangible book of around 95%. It hasn't traded under tangible book value since 1999.

The management of WTM has indicated that they would probably resume buying shares back at this price as well, subject to a normal catastrophe season. This will provide some support to the shares.

Raymond Barrette, the Chairman and Chief Executive Officer of WTM, made an open market purchase of company shares just last month. He purchased 2,000 shares at prices between $441.52 and $445.

It is easy to indiscriminately sell all financial stocks during this trying time that we find ourselves in, and that is certainly what many investors are doing. A better strategy would be to purchase stocks that have been sold down more than justified based on fundamentals.

Disclosure - I am long WTM.

This article was written by The Stock Market Prognosticator. You may email questions or comments to me at info@brittaincapitalmanagement.com.

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