AMERISAFE INC AMSF S
December 31, 2009 - 7:51pm EST by
skyhawk887
2009 2010
Price: 17.96 EPS $2.48 $1.80
Shares Out. (in M): 19 P/E 7.3x 10.0x
Market Cap (in $M): 339 P/FCF 0.0x NA
Net Debt (in $M): 37 EBIT 62 53
TEV ($): 376 TEV/EBIT 6.0x 7.0x
Borrow Cost: NA

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Description

 

Based in DeRidder, Lousiana (population: 9,800), Amerisafe is a workers comp insurance company focused on small and mid-sized employers engaged in hazardous industries such as commercial construction, trucking, agriculture, logging, oil and gas, maritime, and sawmills. Of note, AMSF generated approximately 40% of its 2009 premium volume from the commercial construction sector, which will likely cause severe headwinds in premium growth for the next couple of years. After peaking in 2006 (see chart below) gross premiums fell 1% in 2007, another 6% in 2008, 15% in the first nine months of 2009, and finally accelerated to -27% in the Q3/09 alone. I believe gross premiums will likely be down another 5-10% in 2010 (vs. the sell-side which is projecting flat or down 1-2%). While the company has launched some initiatives to offset the sharp declines (i.e. geographic expansion into Iowa and Alaska and industry expansion into auto mechanics), I think these will be minimal as the company’s inherent conservatism will prevent it from aggressively expanding into areas where it doesn’t have a lot of experience. The following link provides a very informative and easy-to-understand presentation on AMSF. It is worth spending a few minute perusing: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjU3NDA3OXxDaGlsZElEPTM2MTYzNnxUeXBlPTI=&t=1  

Additionally, as its $717M investment portfolio continues to reprice to the lower interest rate environment, investment/interest income should also continue to fall. Investment income was $6.9M in Q3/09, down 10% over the year. You can see the trend in the chart below. 

  2002 2003 2004 2005 2006 2007 2008 2009E Q1/09 Q2/09 Q3/09
Gross Prem. Written 185 224 265 291 332 328 309 262 79 73 55
Net Prem. Earned 163 180 235 257 299 307 289 255 70 66 58
Invest Income 9.4 10.1 12.2 16.9 25.4 30.2 31 28 7.4 7.0 6.8
Loss Ratio 74% 72% 74% 80% 67% 65% 61% 62% 67% 61% 57%
Current year LR 73% 71% 69% 71% 67% 68% 68% 69% 69% 69% 69%
Prior year LR 1% 50% 6% 9% -1% -3% -7% -7% -2% -8% -12%
Expense Rate 30% 28% 25% 25% 26% 21% 21% 22% 21% 22% 22%
Combined Ratio 104% 100% 100% 104% 92% 86% 81% 84% 89% 83% 79%
Net Inc. to Common -4.3 -1.5 0.5 -2.7 33.1 47.2 53.8 48 10.4 12.9 14.2

 

What the above table should also reveal is that AMSF is in a very cyclical industry. Underwriting profits have been stellar the last few years (84-92% combined ratio since 2006), but its experience in the early part of the decade with combined ratios at or above 100% for four years is indicative of the problems that can occur, especially in a declining revenue environment where operating leverage will be negative. 

Recent Results
AMSF blew away Q3/09 results with EPS of $0.67 vs. consensus estimate of $0.54. All of the beat was driven by reserve releases. For you non-specialists out there, that basically means the estimated loss content of insurance written in previous years has been less than expected. This is evident in the table above where you can see that the loss ratio from prior years was -12% in the quarter. Much of the insurance industry has been experiencing favorable prior year loss development, but this is unsustainable and considered low quality earnings. Tellingly, AMSF traded down on the day it released results despite the beat because the critical variable was the premium volume, which was down sharply. 

AMSF also recently repaid $25M in convertible preferred stock, which had some strict covenants attached, the most important of which were no dividends for the common stock and no stock buybacks. While some on the sell-side have seized on this as a positive catalyst, I believe insurance companies with sharp declines in revenue will not be well-served by repurchasing stock at a premium to book.  
 
 

Valuation
AMSF trades at 119% times Q3/09’s diluted book value of $15.32 and will probably be near $15.85 at year-end. With many profitable insurance companies currently trading at or below book value, 1.0 times book value represents an appropriate value for Amerisafe. With the stock at $18.20, there is 13% downside.  

 

Catalyst

 

Continued decline in premium volumes

Declining investment income

Worsening loss ratios and operating leverage

 

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    Description

     

    Based in DeRidder, Lousiana (population: 9,800), Amerisafe is a workers comp insurance company focused on small and mid-sized employers engaged in hazardous industries such as commercial construction, trucking, agriculture, logging, oil and gas, maritime, and sawmills. Of note, AMSF generated approximately 40% of its 2009 premium volume from the commercial construction sector, which will likely cause severe headwinds in premium growth for the next couple of years. After peaking in 2006 (see chart below) gross premiums fell 1% in 2007, another 6% in 2008, 15% in the first nine months of 2009, and finally accelerated to -27% in the Q3/09 alone. I believe gross premiums will likely be down another 5-10% in 2010 (vs. the sell-side which is projecting flat or down 1-2%). While the company has launched some initiatives to offset the sharp declines (i.e. geographic expansion into Iowa and Alaska and industry expansion into auto mechanics), I think these will be minimal as the company’s inherent conservatism will prevent it from aggressively expanding into areas where it doesn’t have a lot of experience. The following link provides a very informative and easy-to-understand presentation on AMSF. It is worth spending a few minute perusing: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjU3NDA3OXxDaGlsZElEPTM2MTYzNnxUeXBlPTI=&t=1  

    Additionally, as its $717M investment portfolio continues to reprice to the lower interest rate environment, investment/interest income should also continue to fall. Investment income was $6.9M in Q3/09, down 10% over the year. You can see the trend in the chart below. 

      2002 2003 2004 2005 2006 2007 2008 2009E Q1/09 Q2/09 Q3/09
    Gross Prem. Written 185 224 265 291 332 328 309 262 79 73 55
    Net Prem. Earned 163 180 235 257 299 307 289 255 70 66 58
    Invest Income 9.4 10.1 12.2 16.9 25.4 30.2 31 28 7.4 7.0 6.8
    Loss Ratio 74% 72% 74% 80% 67% 65% 61% 62% 67% 61% 57%
    Current year LR 73% 71% 69% 71% 67% 68% 68% 69% 69% 69% 69%
    Prior year LR 1% 50% 6% 9% -1% -3% -7% -7% -2% -8% -12%
    Expense Rate 30% 28% 25% 25% 26% 21% 21% 22% 21% 22% 22%
    Combined Ratio 104% 100% 100% 104% 92% 86% 81% 84% 89% 83% 79%
    Net Inc. to Common -4.3 -1.5 0.5 -2.7 33.1 47.2 53.8 48 10.4 12.9 14.2

     

    What the above table should also reveal is that AMSF is in a very cyclical industry. Underwriting profits have been stellar the last few years (84-92% combined ratio since 2006), but its experience in the early part of the decade with combined ratios at or above 100% for four years is indicative of the problems that can occur, especially in a declining revenue environment where operating leverage will be negative. 

    Recent Results
    AMSF blew away Q3/09 results with EPS of $0.67 vs. consensus estimate of $0.54. All of the beat was driven by reserve releases. For you non-specialists out there, that basically means the estimated loss content of insurance written in previous years has been less than expected. This is evident in the table above where you can see that the loss ratio from prior years was -12% in the quarter. Much of the insurance industry has been experiencing favorable prior year loss development, but this is unsustainable and considered low quality earnings. Tellingly, AMSF traded down on the day it released results despite the beat because the critical variable was the premium volume, which was down sharply. 

    AMSF also recently repaid $25M in convertible preferred stock, which had some strict covenants attached, the most important of which were no dividends for the common stock and no stock buybacks. While some on the sell-side have seized on this as a positive catalyst, I believe insurance companies with sharp declines in revenue will not be well-served by repurchasing stock at a premium to book.  
     
     

    Valuation
    AMSF trades at 119% times Q3/09’s diluted book value of $15.32 and will probably be near $15.85 at year-end. With many profitable insurance companies currently trading at or below book value, 1.0 times book value represents an appropriate value for Amerisafe. With the stock at $18.20, there is 13% downside.  

     

    Catalyst

     

    Continued decline in premium volumes

    Declining investment income

    Worsening loss ratios and operating leverage

     

    Messages


    SubjectPaired Trade?
    Entry01/03/2010 01:12 PM
    Memberdavid101

    Skyhawk,

     

    Any thoughts on doing a paired trade with a cheap P&C insurer?

     

    David


    SubjectRE: Paired Trade?
    Entry01/04/2010 09:54 AM
    Memberlvampa1070

    For a long idea, consider EIHI, which is at a large discount to book value (maybe its 70% now...double check). EIHI is a workout stock but its main line of business is workers comp. A cheap workers comp stock is SBX, but I do not recommend a long position in that. 


    SubjectRE: RE: Paired Trade?
    Entry01/04/2010 06:52 PM
    Memberskyhawk887

    A lot of insurance names are inexpensive on traditional metrics, but I think with good reason, given weak top-line growth and the unsustainability of favorable reserve developments.

    Some of AMSF's pure-play workers' comp competitors include EIG, SBX, and ZNT. I think SBX's downside at 70% of book value is minimal (although they do have a lot of California exposure) and EIG'd downside at 75% of book (and buying back stock) is also limited. I think either one could make a decent pair trade. ZNT is an interesting animal, trading at over 100 times 2009 EPS, 50 times 2010 and 105% of book value. The founder and CEO, Stanley Zax, is a legend in the business, however, and has a rather devoted shareholder base that likes the $2 dividend (6.7% yield, but is well in excess of the earnings). They are also heavily exposed to the crappy California jobs market which should put a lid on premium growth for the foreseeable future. You might not make a ton of money shorting it, but upside risk is minimal.


    SubjectBig Q4 miss, weak revenue
    Entry03/04/2010 07:40 PM
    Memberskyhawk887

    AMSF reported a weak Q4 of $0.32 vs. $0.58 consensus primarily because the loss rate spiked up due to  several incidents at their customers, including an unfortunate explosion that injured multiple individuals. Bulls dismiss this as a one-off item, and I don't really disagree, but this is the nature of AMSF's business--high hazard workers' comp where a few claims can really cause losses to spike.

    More importantly, for the short thesis, gross premiums were down 24% in the quarter, much worse than most of the sell-side was anticipating.

    While my price target was merely book value (now $16), two of AMSF's direct workers' comp peers--EIG and SBX--are trading at 65-70% of book. AMSF is looking awfully expensive by comparison.

    Positively, they did announce a first-time ever share repurchase authorization ($25M), but I don't think buying stock above book in the midst of such a sharp premium and revenue decline is a good idea.


    SubjectZNT
    Entry03/04/2010 07:43 PM
    Memberskyhawk887

    FYI,

    I was wrong on not losing on the short on Zenith, which was recently bought at a 30%+ premium by Fairfax's Prem Watsa. I think this was a unique deal given the relationship the two companies have had in the past and Zax's age and unique status in the industry. I think Watsa is smoking crack on this purchase, but he obviously has an excellent track record and has made some great bets recently.


    SubjectGood opportunity to establish short position
    Entry06/25/2010 11:22 PM
    Memberskyhawk887

    The stock has spiked up in the last couple of weeks on no news.

    My original thesis to short the company on sharply declining revenue is still very much in play. After q4/09 results, that showed premiums down 27%, Q1/10 premiums were down 23%. One sell-side analyst was projecting down only 9%-- one indication of how far off the sell-side is.

    Oppenheimer also downgraded the stock yesterday.

    CEO Allen Bradley was on a panel discussion at a recent conference (Oppenheimer) and he commented that competition still remains "intense." He also noted that opportunities from the BP disaster (AMSF is based in LA) are limited.

    AMSF is trading at 11 times my $1.70 estimate of earnings and 112% of book. Perhaps it is not overly expensive on an absolute basis, but there are lots of high quality insurers trading at 8 times earnings and below book value and are NOT seeing their top-line fall by 20%+.

    This is a good opportunity to establish a short position.


    SubjectRE: Author Exit Recommendation
    Entry02/08/2011 11:10 PM
    Memberskyhawk887
    This short worked out ok over the last 13 months, delivering a +3% absolute return and underperforming a bullish market by 20%. Q4 earnings to be reported in early March shouldn't be very good, but the stock is now just about at 100% of its Q3/10 $17.26 book value, or closer to 90% if you include $2 per share in non-marked gains in its held-to-maturity bond portfolio.
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