November 17, 2009
Research Associate: Meenu Goyal, M.Fin.
Editor: Tanuka De, M.Com., MBA
Sr. Ed.: Ian Madsen, CFA; ; 1-800-767-3771, x9417
www.zackspro.com 111 N. Canal Street, Suite 1101 l Chicago, IL 60606
Markel Corporation / (MKL–NYSE) / $327.90*Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q09 Earnings Update
Previous Edition: 2Q09 Earnings Update, August 17, 2009 (brokers’ material considered till August 10)
Brokers’ Recommendations: Positive: 44.0% (4 firms); Neutral: 33.0% (3); Negative: 23.0% (2) Prev. Ed.: 4; 4; 2
Brokers’ Target Price: $351.57 (↑ by $20.24 from the last edition; 7 firms) Brokers’ Avg. Expected Return: 7.2%
*NOTE: Though dated November 17, share price is of November 17; broker material is as of November 10.
Note: A flash update on 3Q09 earnings was done on November 6, 2009.
Note: The tables below for Revenue, Margins, and Earnings per Share contain less brokers’ material than the brokers’ material used in the Valuation table. The extra figures in the Valuation table come from reports that did not have accompanying spreadsheet models.
Portfolio Manager Executive Summary
Markel Corporation (MKL or the Company) is an international property and casualty insurance holding company headquartered in Richmond, VA. It sells specialty insurance products and programs to a variety of niche markets and believes that its specialty product focus and niche market strategy enables to develop expertise and specialized market knowledge. It differentiates itself from its competitors by reason of its expertise, service, continuity, and other value-based considerations. The financial goals are to earn consistent underwriting profits and superior investment returns to build shareholder value.
44.0% of firms in the Digest group were positive on the stock, 33.0% held a neutral outlook, and the remaining 23.0% were negative. The firm with the lowest target price of $248.00 did not provide any valuation metric and rated the stock Underperform. The firm with the highest target price of $450.00 based the valuation on 1.80x projected FY09 book value per share of $298.89 and rated the stock Buy.
Neutral and negative or equivalent outlook – Five firms or 56.0% - Target Price range of $248.00-$350.00. These firms believe the Company’s liability management results, i.e. the insurance business, have been below par in recent years due to the prolonged and difficult transition of its 2000 Terra Nova acquisition. However, this business is currently well reserved and properly underwritten. Management has been pessimistic regarding premium rates as it mentioned that rates within the property and casualty insurance marketplace declined to a greater extent than expected and are approaching unprofitable levels. These firms expect the Company to pull back its underwriting in the near term, which may make earnings growth difficult.
Buy or equivalent outlook – Four firms or 44.0% - Target Price range of $373.00-$450.00: Markel has been the most specific insurer with respect to planned rate increases, reflecting its well-entrenched underwriting discipline and its specialty book of business, which is less exposed to competition. This discipline, combined with its focused investment philosophy and conservative reserving practices, should sustain steady book value growth in 2009 and beyond, even in the absence of a rapid recovery in the P&C markets. According to the firms, MKL has a track record of delivering significant book value growth, given time to execute its strategy. The firms consider MKL as a profitable investment both in terms of underwriting operations and investment ability of the firm. However, a patient investor base focusing on long-term results yielded successful results for the Company.
November 17, 2009
Recent Events
On November 4, 2009, Markel Corporation announced its 3Q09 financial results. Highlights are as follows:
· Net premiums earned were $448.4 million versus $516.1 million in 3Q08.
· Net investment income was $66.6 million versus $68.2 million in 3Q08.
· Total revenue was $485.3 million versus $415.6 million in 3Q08.
· Operating income was $53.7 million versus an operating loss of $227.9 million in 3Q08.
· Net income was $59.1 million versus a net loss of $142.3 million in 3Q08.
· EPS was $6.02 versus a loss per share of $14.46 in 3Q08.
On October 30, 2009 MKL announced that its Markel Ventures subsidiary acquired Panel Specialists, Inc., a privately held company based in Temple, Texas that manufactures panels, wall systems, casework, furniture, and countertops and other stone-related products. Terms of the transaction were not disclosed
Overview
Brokerage firms identified the following factors for evaluating investment merits of MKL:
Key Positive Arguments / Key Negative Arguments· High quality management
· Well-diversified product line
· Strong balance sheet
· High investment leverage
· Management indicated that it is open to acquisitions to maintain growth, as it has done in the past, in moderating pricing environments
· Favorable earnings trends and outlook
· Better combined ratio
· Operating cash flow improvement / · Intensified competition in MKL’s markets
· High equity exposure
· Catastrophic events
· Softening market conditions
· The need for further reserve additions
Based in Glen Allen, Virginia, Markel Corporation (MKL or the Company) and its subsidiaries market and underwrite insurance products and programs in the U.S and internationally. It operates in three segments: Excess and Surplus Lines, Specialty Admitted, and London Insurance Market. The Excess and Surplus (E&S) Lines segment writes property and casualty insurance, including catastrophe-exposed property, professional liability, products liability, general liability, commercial umbrella, and other coverage. The Specialty Admitted segment writes specialty program insurance, personal and commercial property, and liability coverage. The London Insurance Market segment writes specialty property, casualty, professional liability, and marine insurance, as well as reinsurance. The Company’s website is www.markelcorp.com.
NOTE: The Company’s fiscal year coincides with the calendar year.
November 17, 2009
Revenue
Revenue, as compiled by Zacks Digest, is shown in the table below:
Revenue ($ in Million) / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010E / 2011EDigest High / $584.3 / $1,898.3 / $504.8 / $485.3 / $508.0↓ / $2,069.7↓ / $489.7 / $1,957.1↓ / $1,912.0
Digest Low / $415.6 / $1,898.3 / $504.8 / $485.3 / $484.6↓ / $1,945.9↓ / $481.2 / $1,892.0↓ / $1,912.0
Digest Average / $457.3 / $1,898.3 / $504.8 / $485.3 / $496.2↓ / $1,982.6↓ / $485.5 / $1,929.3↓ / $1,912.0
YOY Growth / -26.0% / -23.1% / -15.8% / 6.1% / 38.8% / 4.4% / 3.0% / -2.7% / -0.9%
Sequential Growth / -23.7% / 7.2% / -3.9% / 2.3% / -2.2%
Zacks Consensus / $511.0↓ / $2,013.0↓ / $485.0 / $2,012.0↓
Total revenue, as per the Zacks Digest model, was $485.3 million in 3Q09, up 6.1% y-o-y from $457.3 million in 3Q08 and up 7.2% from $504.8 million in 2Q09.
Gross written premiums decreased 14% from 2Q09 attributable to intense competition and the effects of current economic environment. Also, contributing to the decline was forex movement in its London Market segment, which impacted growth by 2%.
In 3Q09, Net written premiums stood at $430.9 million down from $498.1 million in 3Q08. The decline was attributable to Excess and Surplus lines premiums down 17% y/y, Specialty Admitted down 13% y/y, and Markel International down 6% y/y. Decreases reflect exited business due to competitive pricing and weak economic conditions.
Favorable development of prior year reserves was $61.0 million in 3Q09.
The investment portfolio was a bright spot during 3Q09 as the company reported another strong rebound in invested assets across all aspects of the investment portfolio. Net investment income was $66.6 million versus $68.2 million in 3Q08, reflecting lower-than-expected yields on the fixed income side of the portfolio.
Net realized investment losses totaled $29.8 million in 3Q09 ($1.97/share), which related to one equity security, four fixed income securities, and one investment in affiliates. The company reported total unrealized gains of $277.5 million during 3Q09, continuing the strong rebound that started in March 2009.
Revenue components, as compiled by Zacks Digest, are shown in the table below:
Revenue Components / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010E / 2011ENet Premium Earned / $514.5 / $2,022.2 / $455.3 / $448.4 / $430.1↓ / $1,791.0 ↓ / $416.5 / $1,653.0↓ / $1,633.6
Net Investment Income / $69.3 / $283.7 / $65.0 / $66.7 / $66.1 ↓ / $266.9 ↓ / $69.0 / $276.2 ↓ / $278.3
Net Realized Investment Gains / ($168.7) / ($407.6) / ($15.4) / ($29.8) / NA / ($100.4) ↓ / NA / $0.0 / NA
Total Revenue / $457.3 / $1,898.3 / $504.8 / $485.3 / $496.2 ↓ / $1,982.6 ↓ / $485.5 / $1,929.3↓ / $1,912.0
Please refer to the separately published spreadsheet of MKL for additional details and updated forecasts.
Margins/Combined Ratio
Margins, as compiled by Zacks Digest, are shown in the table below:
Margins / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010E / 2011EOperating / -12.9% / 15.5% / 13.2% / 17.2% / 13.5%↑ / 14.2%↑ / 17.3% / 15.3%↑ / 15.0%
Pre-tax / -15.4% / 12.4% / 10.9% / 14.7% / 8.6%↓ / 12.5%↓ / 14.1% / 13.6%↓ / 15.0%
Net Operating / -7.1% / 10.9% / 8.5% / 16.2% / 7.4%↑ / 10.6%↑ / 11.0% / 8.6%↑ / 11.6%
Operating margin, as per the Zacks Digest model, was 17.2% in 3Q09 versus (12.9%) in 3Q08. Pre-tax margin, as per the Zacks Digest model, was 14.7% in 3Q09 versus (15.4%) in 3Q08.
Combined Ratio
Combined ratio is the percentage of each premium dollar spent on claims and expenses, and the lower the ratio, the better is the performance.
The combined ratio in 3Q09 was 96.0% compared to 124% in 3Q08. The combined ratio was 97% for the nine months ended September 30, 2009, compared to 104% for the same period of 2008. The combined ratio for the quarter and nine months ended September 30, 2008, included $115.1 million, or 22 points and 8 points, respectively, of underwriting loss related to Hurricanes Gustav and Ike.
The E&S segment produced a combined ratio of 93.8% in 3Q09. The International segment’s combined ratio stood at 91.3% in 3Q09. Accident year loss ratios continue to move higher, reflecting softer pricing and continued erosion in the premium base.
Markel’s 3Q09 expense ratio stood at 43.1% in 3Q09, reflecting costs associated with the One-Markel program
Outlook
The Zacks Digest model projects average y-o-y growth rates in operating expenses of (13.0%) and (8.5%) for 2009 and 2010, respectively, compared to an estimated y-o-y growth rate in total revenue of 4.4% for 2009 and (2.7%) in 2010.
Please refer to the separately published spreadsheet of MKL for additional details and updated forecasts.
Earnings per Share
The company reported diluted net income per share of $6.02 for the quarter ended September 30, 2009, compared to diluted net loss per share of $14.46 in 3Q08.
As per the Zacks digest model, net operating income was $78.5 million in 3Q09 versus ($32.6) million in 3Q08 while reported net income was $59.1 million versus ($142.3) million in 3Q08.
As per the Zacks Digest model, operating EPS in 3Q09 was $6.89, up 307.8% from ($3.31) in 3Q08.
EPS as compiled by Zacks Digest are shown in the table below:
EPS (In $) / 3Q08A / 2008A / 2Q09A / 3Q09A / 4Q09E / 2009E / 1Q10E / 2010E / 2011EDigest High / ($3.27) / $21.13 / $4.71 / $8.04 / $5.00↓ / $22.72↓ / $5.74 / $20.87↓ / $22.66
Digest Low / ($3.32) / $20.81 / $4.36 / $4.50 / $1.65 / $11.42 / $2.14 / $6.75↓ / $22.66
Digest Average / ($3.31) / $20.90 / $4.46 / $6.89 / $4.04↓ / $19.21↓ / $4.56 / $16.85↓ / $22.66
Digest YOY Growth / -136.5% / -43.4% / -33.0% / 307.8% / -61.0% / -8.0% / -14.7% / -12.3% / 34.5%
Sequential Growth / -149.7% / -16.5% / 54.2% / -41.3% / 12.7%
Zacks Consensus / $4.62↓ / $21.34↑ / $5.53 / $20.19↓
Highlights from the EPS chart are as follows:
· 2009 forecasts (total 8) range from $11.42 to $22.72; the average is $19.21.
· 2010 forecasts (total 8) range from $6.75 to $20.87; the average is $16.85.
· For FY11, one firm forecasts EPS in the range of $22.66.
On firm (RBC Cap) increased its 2009 operating EPS estimates mainly based on 3Q09 results and reduced its 2010 estimate based upon reduced assumptions for premiums and investment income and a modest reduction in margins, mainly due to a higher expense ratio.
Another firm (BofA Merrill Lynch) increased its EPS estimates for FY09 based on 3Q09 results and expectations for favorable reserve development in 4Q09. However, it lowered the estimate for FY10 due to a higher accident year combined ratio assumption.
Outlook
As per the Zacks Digest model, the analysts expect the share count to decline by 0.5% y-o-y to 9.8 million by the end of 2009 and remain flat y-o-y by the end of 2010 and 2011. This represents a three-year CAGR of (0.1%) on 2008 shares outstanding.
As per the Zacks Digest model, 2011 EPS estimate is expected to increase at athree-year CAGR of 2.7%,driven by 2.6% CAGR projected for net income and partially offset by (0.1%) CAGR for shares outstanding.
Please refer to the separately published spreadsheet of MKL for additional details and updated forecasts.
Target Price/Valuation
Of the nine firms covering the stock, 4 rated the stock positive, 3 rated the stock neutral, and 2 firms conferred negative ratings on the stock. The average target price is $351.57 (↑ by $20.24 from the previous report; 7.2% upside from the current price). The target prices range from $248.00 (24.4% downside from the current price) (Oppenheimer) to $450.00 (37.2% upside from the current price) (Stifel Nicolaus).