Saturday, June 27, 2015

Traveler's Companies (TRV) Stock Analysis

I mentioned just recently when I wrote about adding to my W.P. Carey Inc. (WPC) position that June is shaping up to be one of my busiest months ever in terms of total transactions and total capital put to work.
So it should then come as no surprise that I’m back at it again!
Look, cash is great. I like cash. Smells wonderful. Feels great in the hand.
But cash flow is far, far better. Especially when we’re talking about cash flow that not only automatically replenishes itself, but does so at an increasing rate over time. And that’s what we’re generally talking about when it comes to high-quality dividend growth stocks.
As such, I recently took advantage of an opportunity to turn cash into growing cash flow once more by initiating a position in a company that was on my watch list for this month.
I purchased 10 shares of Travelers Companies Inc. (TRV) on 6/3/15 for $100.61 per share.


Travelers Companies Inc.  is a holding company that, through its subsidiaries, provides a wide range of commercial and personal property and casualty insurance products and services to individuals, businesses, government units, and associations.
Net written premiums for fiscal year 2014 of $23.9 billion broke down by the following segments: Business and International Insurance, 61%; Personal Insurance, 30%; and Bond & Specialty Insurance, 9%.
The company’s consolidated direct written premiums for FY 2014 were mostly domestic, accounting for 91.7%. The other 8.3% were international.


Travelers has an incredible corporate history, dating back to 1853. Though, the recent acquisition (in 2004) of The Saint Paul Companies has turned them into one of the largest property-casualty insurers in the US.
I’m going to first take a look at the last ten years’ top-line and bottom-line growth, which includes that entire period of being a much larger company. As such, it’s an apt look at the fundamentals when looking forward. I’ll then move into some other quantitative data to see what kind of quality we’re working with here.
Revenue $24.365 billion in FY 2005. TRV increased that to $27.162 billion in FY 2014. That’s a compound annual growth rate of 1.21%.
Like many P&C insurers, TRV hasn’t had much revenue growth due to a combination of tepid premium growth and low interest rates constraining net investment income.
Fortunately, the bottom line is faring much better.
Earnings per share is up from $2.33 to $10.70 over this stretch, which is a CAGR of 18.46%.
That growth was in large part due to rather substantial share repurchases – TRV has reduced its outstanding share count by about half over the last decade.
So we see some challenges there across the top line, but incredibly impressive growth in profit per share. And I think that bodes well. If they can grow like that when revenue is challenged, imagine what’s possible when interest rates pick up and/or they’re able to generate better premium growth.
S&P Capital IQ predicts that EPS will compound at a 6% annual rate over the next three years.
So there’s some solid growth here, but if TRV weren’t sharing that growth with shareholders in the form of an increasing dividend, I wouldn’t even be looking at the stock. However, TRV has a rich dividend history.
They’ve increased their dividend for the past 11 consecutive years, ever since the aforementioned acquisition closed.
Although the dividend growth history might be a bit short, I think TRV will eventually sport many decades of dividend growth. In addition, the company has paid uninterrupted dividends for 143 years straight. That includes every major modern war, the Great Depression, the Great Recession, and multiple stock market crashes.
The 10-year dividend growth rate stands at a stout 9.5%. In fact, they just announced a 10.9% dividend increase in April.
And because the company’s underlying earnings have grown faster than the dividend, the payout ratio remains a very reasonable 23.7%. So there’s plenty of room for future raises, which goes back to why I think TRV will eventually have a track record of many decades of dividend growth.
In addition to that solid growth and low payout ratio, the stock offers a pretty attractive yield of 2.43%.
So I think there’s just a lot to like here with the dividend. Growth, yield, and sustainability all look great.
TRV, as one would expect, also maintains a very conservative balance sheet. The long-term debt/equity ratio is just 0.26. And an interest coverage ratio of 14.7 indicates no issues at all with interest expenses or debt.
Profitability is also robust, comparing extremely well with the broader industry as well as near peers. They’ve averaged net margin of 11.13% and return on equity of 11.41% over the last five years.
One other key profitability metric that you want to look at with insurers is the combined ratio. The combined ratio is what you arrive at when taking the sum of incurred losses and expenses and dividing that by earned premiums. Anything less than 100% generally indicates underwriting profit; anything over 100% means that claims are exceeding premiums.
TRV’s combined ratio is generally very solid. For FY 2014, it was 89%. I took a look at these figures going all the way back to FY 2006 and they’ve generally been well below 100% except for FY 2011. Travelers was hit by a confluence of Hurricane Irene, wildfires in Texas, costly tornadoes in Alabama and Missouri, and an October snowstorm. And FY 2012 saw a rather high combined ratio (though, not exceeding 100%) due to Hurricane Sandy.

Qualitative Aspects

I truly love the insurance industry. Sure, there are always those chances of getting hit by a catastrophe. But, by and large, it’s an incredible way to make money.
First, you have (or should have) efficient and conservative underwriting in place. This allows for a profitable business model all by itself. If the company is prudent, they’re going to profit some from the difference between premiums and claims. In addition, premiums naturally rise over time due to replacement costs. Add in the possibility of additional clients and you potentially have a great profit machine when run correctly.
Now, most insurance companies don’t make tremendous profits from this because the difference between premiums and claims aren’t that generally that high in any one year, especially in competitive business lines. Add in the occasional catastrophe which can inflate the combined ratio above 100%, and that can lead to losses from time to time.
But the insurance model kicks it up a big notch via what’s called the float.
The float is basically the money that can build up because an insurance company collects premiums up front and the difference between premiums and claims can cumulatively become a large sum of money over time. So until a claim is made against them, an insurance company gets to use “other people’s money” as an extremely low-cost source of capital and invest it accordingly. Since the capital is basically free, there isn’t a need to take on a lot of risk to achieve an attractive rate of return. And since that capital might have to be tapped to pay off premiums later, it’s imperative that it be invested conservatively so as to be available if necessary.
Travelers has built up an investment portfolio worth just over $73 billion as of the end of FY 2014. That’s a huge competitive advantage all by itself, which is used to generate significant profit on top of largely profitable underwriting. And the company is incredibly conservative with the money – 93% of the portfolio is invested in fixed maturity and short-term investments, with the vast majority of the funds in a variety of bonds. 97% of that portion of the portfolio is investment grade.
So that’s a massive investment portfolio we’re talking about here, and it’s been built over time through the underlying strength of the underwriting as well as just the robust nature of the business model itself. Due in part to the sheer size of the portfolio as well as the way it’s invested, rising interest rates could provide for a rather strong tailwind for TRV (as well as other major insurers). That could immediately boost EPS through the additional net investment income.
I believe TRV is generally operating a wonderful business model. More specific to the company itself, I think their size confers economies of scale where they’re able to spread out risk and costs across geographies, clients, and business lines. In addition, I believe their expertise is an advantage in and of itself, giving TRV the ability to appropriately and profitably identify the best underwriting opportunities while limiting risk. The company cites advantages through its ability to use data and analytics to properly price their products.
Although it’s tough to differentiate in personal insurance where it’s a pricing game, I really like their exposure to commercial to offset this. And while there aren’t necessarily switching costs with insurance, it seems just as likely that one is going to stick with what they have when there’s a good relationship going on there. It’s similar to how banks and other financial firms work in regards to their stickiness.
Finally, I actually view management as really solid here. I don’t often mention management, but I’ve watched several interviews of CEO, Jay S. Fishman, and the guy strikes me as incredibly intelligent and interested in maximizing shareholder value when and wherever possible, all while maintaining excellent underwriting standards, diversifying the business as much as possible so as to limit catastrophic risk, and staying conservative with the investment portfolio.


The main risks I see are related to the very business model. Any major catastrophes can quickly elevate the combined ratio over 100% across the business and lead to losses in underwriting. Moreover, improper underwriting standards and/or any major changes in climate or weather can cripple TRV’s profit. This adds uncertainty and volatility – EPS dropped by approximately 50% from fiscal years 2010 to 2011 due to natural disasters.
TRV markets its products and services primarily through a network of independent agents and brokers, which can make it difficult to control quality and brand perception.
If low interest rates persist, this could continue to constrain net investment income. In addition, any change in the management of the investment portfolio could add risk and/or the potential for losses. The investment portfolio also has exposure to investments outside of fixed income, which could prove volatile. Furthermore, any negative changes in the credit profile for any of the underlying entities that issue the bonds that TRV invests in could adversely affect TRV’s portfolio.
In addition, the insurance industry is highly competitive, especially in personal lines and especially in personal auto insurance. Pricing pressure in certain business lines could limit growth.


TRV’s stock trades hands for a P/E ratio of 9.76. That compares favorably to the five-year average of 10.7. And it’s obviously well below that of the broader market.
I valued shares using a dividend discount model analysis with a 10% discount rate and an 8% long-term dividend growth rate. That growth rate is on the upper end of what I usually use, but I think TRV warrants it here with the quality of the business, potential tailwinds when looking out over the long term, low payout ratio, and historical growth. The DDM analysis gives me a fair value of $131.76.
It appears to me that, overall, shares appear attractively valued here with a potentially large margin of safety present depending on how much the company and the dividend grows in the future.
The stock is down about 5% YTD even while the broader market is well into positive territory for 2015. I’m not sure that’s warranted based on the where the business is currently at.


There’s a lot to like here with TRV. The business model is really one of my all-time favorites. Insurance is ubiquitous and largely necessary. And it can be very profitable in and of itself, but the float adds an incredible source of profit that ends up being very low cost and low risk.
I think there are potential tailwinds in place that can add to TRV’s already impressive growth. Rates will likely rise, perhaps significantly, looking out over the next five or ten years, which could allow the very large investment portfolio to work that much harder. In addition, TRV’s international business is growing quickly – it was up 66% YOY in FY 2014.
I’ve historically done well with insurance investments, so this is an industry I feel really comfortable with. The business model is very easy to understand and it’s been around for a very long time. Furthermore, I don’t see it radically changing over the foreseeable future, other than maybe risk shifting and being modeled differently if/when self-driving cars become prevalent. But personal auto is a relatively small portion of TRV’s overall business.
One thing to be aware of is that due to the aforementioned catastrophic risk, TRV’s stock can occasionally drop precipitously when earnings drop on the back of significant claims. So I’d like to average my way into this stock over time, just in case something like that happens. But just like you can’t time the market, you obviously can’t time (or hope for) catastrophic events.
This is a company I was strongly looking at in the fall of last year, and I regret not picking it up back then. But I’ve discussed my desire to expand my insurance holdings, so I’m incredibly pleased to finally make a move toward that end. Unfortunately, HCC Insurance Holdings, Inc. (HCC), another insurance stock I’ve long wanted to get my hands on, is apparently being acquired. Can’t win them all.
This purchase adds $24.40 to my annual dividend income, based on the current $0.61 quarterly dividend.
I’m going to include current valuation opinions from other analysts below, which I use to concentrate my reasonable valuation estimate:
Morningstar rates TRV as a 3/5 star valuation, with a fair value estimate of $108.00.
S&P Capital IQ rates TRV as a 4/5 star “buy”, with a fair value calculation of $118.40.
I’ll update my Freedom Fund in early July to reflect this recent purchase.
Full Disclosure: Long WPC and TRV.

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