Value Microcaps Motherboard

[mandjb]

UVE (14.74) Negative writeup on VIC

UVE, Universal Insurance Holdings on the surface looks like it COULD be a great value stock pick:

-Buying back lots of stock (share count from 41.2mm to 35.2mm: -15% over the last 5 quarters)

-A growing dividend and reasonable yield of 3.3%

-Trading at 8.5X P/E

-ROE of 35%+

-Growing fast: doubling revenue and profits over the last few years

BUT: UVE is an insurance company where these kinds of superficial value metrics can reverse course rapidly and are a mere “second derivative” of the asset base. UVE appears to be one of the most overvalued insurance companies in the market and could fall by 50% to return to normalized levels or much worse if there is a large wind event in Florida. At its current market cap around $500mm, UVE trades at 2.7X Price /Book which is higher than any other P&C insurance company in the market that I could find based on that metric. For comparison, Progressive Insurance has traded fairly consistently at ~2.3X P/B and has one of the more sustainable competitive advantages of any P&C company.

The stock buybacks last year were at bargain prices and did increase the intrinsic value per share but there was a colorful story to it as they were buying the stock back from a CEO who resigned after a regulatory investigation. More recent stock buybacks appear to be highly value destructive given the valuation.

Similar to HCI, which was written up last year on VIC, UVE’s primary business is Florida wind. Historically this has been an unprofitable line of insurance and so the biggest player has been the government run Citizen’s. Over the past couple years, like HCI and others, UVE has been able to boost their revenues and profits by using “take-outs” where insurers can take over policies from Citizens in bulk and cherry pick profitable policies: effectively a loophole allowing a wealth transfer from the tax payer to these private companies.

Over a year ago Citizen’s brought in a new tough CEO to end this taxpayer scalping and instituted a clearing house so the policies would be competitively bid. Since the last bulk take-outs Nov 2013, the out process has been unavailable to boost revenues and profits in big chunks. More importantly for the timing of this short – the TTM comps are just about to roll off so I would expect to see financials reverse from growing to shrinking revenues and profits. The bulls who are extrapolating growth will find themselves highly disappointed in the near future.

*Just after I wrote this draft* UVE did just participate in a recent large round of take-outs that will go into effect for November (http://www.floir.com/siteDocuments/Takeouts/TakeoutsSummary2014.pdf) where they can take out up to 51,293 policies so they may be able to keep up the revenue growth for another little bit given the highly competitive nature of this take-out, it seems unlikely they will be able book margins anywhere close to what they have in the past.



Buffett has said that it’s not possible to judge the true value of a financial institution by its numbers alone as the true risk comes from the culture of the organization. Well, here are a few cultural elements to consider what skeletons may be hidden in the closets in the event that there is a wind event (after an incredibly long stretch since Katrina since anything meaningful).

- CEO resigned early 2013 after a scathing regulatory report (and $1.3mm fine) in response to his losing excessive amounts of money trading gold mining stocks while racking up large brokerage commissions: http://www.propertyinsurancecoveragelaw.com/uploads/file/FOIR_Order.pdf

- Sketchy post-loss underwriting and shirking claims:

http://www.propertyinsurancecoveragelaw.com/2013/04/articles/consumer-protection/what-a-coincidence-universal-property-casualty-engages-in-postloss-underwriting-and-makes-30-million-in-profits/

- More commentary and context: http://www.tampabay.com/opinion/editorials/editorial-root-out-insurer-abuses/2124592



What is UVE worth?

Loss Ratio for UVE:

2009: 74.9%

2010: 66.5%

2011: 62.5%

2012: 54.6%

2013: 40.6%



It’s clear that a company without any long term sustainable advantage will have competition erode excess margins (ROE 35%+ and loss ratios steadily declining). A fair value of 1x book value for such an enterprise seems like fair value though the downside optionality at UVE given the scary risk culture in the event of a significant wind event makes me think <1x BV would be more appropriate.