Hanover Insurance: Slow And Steady Wins The Race

Hanover Insurance: Slow And Steady Wins The Race

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Insurance companies have been out of favor this year, partially because their ability to earn dollars on their investment war chests has diminished with interest rates, but also because 2020 in the US stock market was one of growth stocks. Insurance companies are about as far as you can get from growth stocks, but for investors that prefer the slow and steady pace to the goal, they can offer good value and decent dividend income to boot.

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Hanover Insurance Group (THG) is just such a stock that I see as offering long-term holders strong value today. This one will not make you rich overnight, but if you’re after good value, a sustainable business model, and growing dividends, you can do a lot worse.

Slow and steady

Hanover is a property and casualty insurer, like many others in the US. It operates in three segments, including Commercial, Personal, and Other. Hanover provides a wide variety of insurance products, including automobile, workers’ compensation, marine, general liability, property insurance, homeowner’s, etc.

Hanover has demonstrated immense staying power, having been founded in 1852. It should generate about $4.6 billion in revenue this year, and has a current market capitalization of $4.2 billion, so its scale is substantial.

Part of the investment thesis for Hanover today is that it is performing extremely well during what can only be described as challenging times. With many companies around the world struggling with reduced demand and profitability, Hanover is more or less fully recovered from the initial shock.

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Source: Investor presentation

This infographic from the Q3 earnings presentation shows some recent historical context on the company’s KPIs, including net premiums written, and its combined ratio. These two metrics are what amount to revenue and gross profit for most businesses, so they are critical. Hanover has seen net premiums written rise year-over-year as of the third quarter, following a COVID-driven Q2 decline this year. It certainly appears revenue is back on track after what amounted to a hiccup, and that’s key considering how cheap the stock is.

The company’s combined ratio was just 88.6% in Q3, and was even lower in Q2. I would suggest Q2’s combined ratio was unsustainably low, driven by a lack of normal activity that generates claims for insurance companies. This includes things like auto accidents, as an easy example. We cannot expect the combined ratio to remain at 88% necessarily either, but the point is that Hanover’s margins have not suffered as a result of COVID. Indeed, in a strange twist, they’ve improved. Insurance companies have a diversifying impact on investors’ portfolios for this reason, among others.

Book value has held up quite nicely as well, as Hanover has managed to expand its book value by more than $6 per share in the past year, up to $84.32 as of the end of Q3. Operating income for the first nine months of the year was fractionally lower, but on the whole, Hanover is performing as though it is seeing essentially no impact from COVID.

Why it matters

This matters because the stock has taken a beating this year, when it simply shouldn’t have. If you’re an investor with a long horizon, this sort of thing should make you salivate. Below, we have the price to forward adjusted earnings for the past five years, and I think it is pretty telling.

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Source: TIKR.com

The stock is well below much of the past five years, and apart from 2020 values post-COVID, its current value would be very near a five-year low. In other words, investors are punishing Hanover’s valuation when there is no fundamental reason to do so. I see upside to ~16 times normalized earnings based upon this data.

The interesting thing is that Hanover trades for just 12.7 times next year’s earnings, so it certainly appears to be cheap at this point.

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Source: Seeking Alpha

Earnings growth is expected to remain ~5% annually, so it isn’t like Hanover is a melting ice cube that needs to be discounted. The stock is just cheap, and I cannot explain why. If we do get a rally into 2021 to 16 times earnings, the stock will see a price of ~$145, up nicely from the $115 it is today.

Further, estimates for EPS are still beaten down, so I think there is ample upside potential there as well.

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Source: Seeking Alpha

Estimates for 2021 are still well below pre-COVID levels, which makes no sense when looking at Hanover’s performance throughout this crisis. We should see – for all intents and purposes – a normal year for Hanover next year. I still think the upward revisions in estimates we’ve seen in recent months is a long way from being done. If I’m right, a higher multiple should follow on even higher EPS estimates, creating further upside potential in the stock.

If it is book value you fancy instead, Hanover is cheap there as well.

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Source: Seeking Alpha

I’ve chosen tangible book value, and the stock is at 1.45x that value today. That is also well below historical averages, with pre-COVID prices at 2x TBV. That’s a huge discount, so even if you don’t believe my higher EPS/higher multiple thesis, this one should look pretty appealing.

Finally, Hanover isn’t just a cheap stock; it pays growing dividends as well.

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Source: Seeking Alpha

Hanover has steadily raised its dividend over the years, having put in 15 years of consecutive increases. The yield is currently 2.4%, so it is decent, but you have reasonable assurance the payout will continue to rise over time. In addition, you can see two significant special dividends that have been paid in recent years, further boosting the overall cash yield.

Final thoughts

Insurance is a boring industry, and the companies that operate in it generally follow suit in terms of excitement. However, if you’re after a stock you can buy and hold for a long time, I think you have to consider Hanover. The stock is cheap by any measure, it pays a growing dividend, and it has staying power. If you’re the sort that believes the tortoise will win the race, you can do much worse than Hanover at $115.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Credit: SeekingAlpha

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