Travelers – A Boring But Stable Grower
|January 28, 2017||Posted by Oddmund Grøtte under Stock Analysis|
I like boring stocks. Travelers (TRV) certainly fits that category. Being a Dow 30 company I’m surprised of the almost complete lack of coverage of this great stock. But I’m happy with that: Less competition. You won’t be instant rich by investing in this stock, but I’m confident you get a decent return for the next ten years. Below I will try to explain why.
TRV is an insurance company. It’s the second largest writer of commercial property casualty insurance in the US and third largest US writer of personal insurance.
First some notes on the insurance business: I assume most of Buffett’s wealth comes from the insurance business. As early as 1967 he bought his first insurance business. According to Forbes Berkshire is involved in almost 70 insurance businesses. This is why Buffett loves the insurance business:
The best with insurance is what is called the float. This is the premiums customers pay to the insurance company for coverage. This is income for the company, and is not given back to customer unless there is a legitimate claim. So for all practical purposes this is an interest free loan. The insurance company can invest the float in for example interest bearing bonds or equity. They pocket the difference as income. However, this is of no use unless the insurance company has a combined ratio that is less than 1. The combined ratio is simply an indicator of the profitability of the company: the incurred losses divided by the earned premiums. Obviously a number less than 1 is indicating a profitable company. TRV has over the last 10 years had a ratio between 0.88 to 0.95, better than the average in the industry. I see no reason why this number should become a lot worse over the last 10 years. However, tha nature of the insurance business is uncertainty. After all, that is why customers pay for insurance. The risk is transferred to the insurance company. However, natural disasters and other freak events is uncontrollable and might create havoc for any insurance business. That is the biggest risk with any insurance company.
Now back to TRV: It currently trades at P/E of eleven, below average in the industry. Premiums are growing, albeit slowly. This is a very competitive business, almost like a commodity. Combined ratio is better than the average, so is the return on equity: 12% versus market average of about 9-10%. Basically all cashflow gets returned to shareholders, mainly via buybacks. Current dividend yield is about 2.2% and will grow because of buybacks.
Intrinsic value per share is rising like a Swiss watch (the last ten years):
During the crisis in 2008/2009 the share price fell a lot less than the market. Max drawdown from peak in 2008 to low in 2009 was about 30%. Remember that insurance is among the last expenses people cut if they run into financial difficulties.
About 90% of their income come from premiums. The remaining 10% or so comes from bonds. 95% of the float ends up in high rated bonds. Only about 5% are invested in risky equity. If interest rates go up, TRV can reinvest at higher interest and increase income.
Below I have tried to make a calculation of what could be the share price in ten years time.
The start is the numbers from 2015. I assume free cashflow will NOT increase over this 10 year period, perhaps too conservative (I like to make all analysis as conservative as possible). The amount set aside for dividends is the same as in 2015 every year (it has been more or less constant over the last ten years). I assume all cashflow after dividend is used for buybacks. The buyback price is set to 160 per share (I am assuming it will rise). As you can see, the table indicates a cashflow per share of about 22 in 2025:
|FCF||Dividend||dividend||#shares||Shares outstanding||FCF/share||Received dividend per share|
This gives a potential share price of 220 with P/E of 10 and received dividends of about 34: in total 254 per share. Today’s share price is 118 so CAGR is about 8%. I think my numbers are pretty conservative, so there is plenty of upside in my calculations. Anyway, with today’s lofty valuations in the stock market, 8% might not be so bad after all.
I already own this stock. On any 10% contraction (or more) I believe this is a great buy. I will certainly add shares on any pullback. Or you can issue puts at for example 110 or 105 some 3-6 months into the future.
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