Federated National (FNHC) Earnings

Federated National Holding Company (FNHC), a company I wrote about over a month ago, reported first quarter earnings last Thursday. Results were great as revenue increased almost 50% and earnings per share increased 123%. Shares were up over 13% on Friday.

Even though the stock is up over 25% from the time I purchased it, I believe there still be more upside left. During the conference call, the CFO stated that business is booming in the current quarter. Last quarter, they were writing $2 million in new business a week. Just last week, they wrote $3.5 million in new business and are on pace to do the same this week. Here is what Peter J. Prygelski, the CFO said:

“I can tell you things weren’t trending favorably for a quite awhile where we used to write a $1 million and then went to $2 million, clearly since we’ve turned on all state, volume has increased. We’ve had more underwriters and more adjusters. I have no reason to believe that flow of premium will slow down. We’ve been at that – we’ve been kind of got up to that level of $3.5 million and I think we are going to hit probably close to that again this week.”

All my previous points remain in tact about FNHC. So, I will continue to hold the shares. The only concern I have is that hurricane season in Florida is approaching and a bad season is always scary for insurers. 

Homeowners Choice (HCI)

Another Florida insurer that has done quite well (much better than FNHC) has been Homeowner Choice (HCI). Even though, I own their bonds, I have concerns about this company:

  • The company was founded in 2006. It does not have much of a track record during the worst hurricanes seasons (2004-2005)
  • HCI has grown solely from assuming policies from the state owned Citizens and defunct companies such as Homeowners Choice. They have assumed policies from them in November of 2011 and 2012 (conveniently after hurricane season). Because hurricane seasons have been tame, the company has done quite well from assuming these policies. Look for them to do the same this year in November. If they don’t, expect revenue and earnings to decline.
  • Company trades at over 2.5 time book value (expensive for an insurance company).They hold most of their assets in cash and do not earn much money from investment income.
  • The company has 20% of their float shorted.
  • Nobody knows how profitable the assumed policies are due to the tame hurricane seasons. Also, the certain Citizens policies have restrictions on rate hikes. 

I don’t see much upside left in this stock. In fact, the company could in for a huge fall if:

  • A major hurricane hits Florida and we find out how profitable/risky these assumed policies are. To quote Warren Buffett, “You never know who’s swimming naked until the tide goes out”
  • At some point, they will not be able to assume policies from Citizens. At this point, expect earnings and revenue to decline.

Buying puts on this stock might be a good strategy.

Disclosure: I am long FNHC and HCJ 

Federated National – Part 2

A reader Jeff S. sent me a good write up about potential risks about insurance companies in general. In the rush of posting this article yesterday, I should have mentioned them as they are important:

Book Value

Insurance companies hold a lot of assets, mainly bonds. The value of those assets shift dramatically depending on market conditions and thus, book value can go up and down dramatically. For example, Federated holds $150 million in cash and investments and the majority of it is in bonds. If the value of those bonds goes down say 10%, we are talking about a $15 million hit to book value or about $2/share. 

When you are investing in insurance companies, you are investing in bonds. Right now, it is not a great time to be an investor in bonds (especially, long term bonds) because of the low interest rates. About 16% of Federated’s portfolio bond portfolio, is in bonds that mature after 10 years. Another point is that any extra cash flow that the company gets will be invested in more bonds at the current anemic rates. 

Loss and loss adjustment expenses

Insurance companies not only have to expense actual paid losses, but also losses they expect to pay in the future. As a result, an overly optimistic management team could increase earnings by underestimating losses they may have to pay in the future.

It is worth noting that losses this year for Federated were stable even with a 20%+ new business. Also, unpaid losses and LAE has gone down $10 million year over year from $59 to $49 million.

Management attributed it to “primarily to a reassessment of our losses by line and increased underwriting procedures to manage our risks.” Federated has been focusing on writing more profitable policies. This has resulted in lower reinsurance premium rates and obviously lower losses. However, I am not a huge fan of the first reason (reassessment of our losses). 

Takeout

One thing I like about Federated is that they have grown organically and not from takeouts (taking business/premiums from other insurance companies). Takeouts result in instant premium growth and a boost to earnings. Homeowners Choice, Inc. (HCI), an another florida insurer, has growth this way, but the Federated CEO is not a fan of this approach and is adding business policy by policy.

Management

You need a good management team to manage risk. In regards to Federated, I can’t say either way they are good or bad, but I do like that they are saying the right things in the conference call.

Conclusion

With any investment, there is risk, but insurance companies are riskier. Federated is still a buy for me as I wrote in my previous article, but  investors should invest with caution.

Disclosure: I own FNHC

Buy Federated National (FNHC)!

Federated National (FNHC) provides homeowners insurance in Florida. It is a very small company:

  • Market capitalization of less than $60 million.
  • No analyst coverage.
  • Average volume of less than 14,000 shares traded daily.

It just reported good fourth quarter earnings over a week ago and since then the stock has surged almost 20% from $6.17 to $7.30 yesterday. However, further gains could be in store for this company as revenues should get a huge boost in 2013.

Background

The state owned Citizens is the largest insurer in Florida. Due to concerns about whether Citizens would be able to pay out claims if major hurricanes hit the state, it has been state approved raising rates over the last couple years with the hopes of writing profitable policies and pushing customers to the private sector. This has had a positive impact on Federated:

  • Over 20%+ growth in gross premiums written in 2012 to almost $120 million.
  • State approved rates rises and disciplined underwriting have decreased loss ratio and increased net income to .53/share in 2012.

2013

Based on management’s comments in the earnings call, 2013 should be even a better year:

  • Significant growth in new business in 2013. Last quarter the company was doing $1 million in new business and this quarter it is doing $2 million business and the CEO feels they could reach $2.5 to $3 million in business. Based on normal retention rates of 90% of existing customers, gross premiums will increase anywhere from 50% to 100%.
  • A signed deal which would allow 700 Allstate agents to write business for Federated has not gone into effect yet. This should help grow new business. 
  • Earnings should increase at a higher rate. Even though most of expenses such as reinsurance are variable, some of the smaller costs are fixed which should significantly help the bottom line with the revenue growth.
  • It is possible that earnings could be over $1/share and book value could increase from $8.26 to over $9+ share.

I bought some shares at $6.59, $7.10, and $7.15. I will most likely buy more at the right price.

There is a good seeking alpha article on the stock.

Disclosure: I own FNHC.