Allied World Assurance: Undervalued And Prudently Managed

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Allied World Assurance Company Holdings, AG ( AWH ) is a Swiss-based insurer and reinsurer with branches in Bermuda, Europe, Hong Kong, Singapore and the United States. It was originally formed in 2001 in Bermuda. Beginning in 2007, Allied World started to actively develop its U.S. insurance business to decrease its reliance on Bermuda -- and in 2010 it changed its domicile to Switzerland. The company is well diversified across product lines, well reserved, and its stock is well priced offering an average earnings yield of some 15%. Let us take a look at Allied World Assurance.

Diversification

Allied has three main operating segments:

Let's break this down further, however, so you can see the diversification. Below is a outline of the U.S. insurance segment, its largest exposure is to casualty:

Check out the International insurance segment:

And the Reinsurance segment:

From this we can see that the largest line of business is property reinsurance, closely followed by U.S. general casualty. With the two largest lines making up 26.7% of premiums, we clearly have an insurer, which is not overly reliant on any one line of business.

Of the $2329m premiums written in 2012, 15% were from the catastrophe reinsurance market -- this is much different than, say, Everest Re ( RE ) or Montpelier ( MRH ), both of whom are heavily concentrated in the cat market. A combined picture of this diversification was supplied by a recent investor presentation (found here (pdf)):

This is to say that Allied's business is hardly dependent on any one line of business. This diversification of risk is probably why the corporation has suffered only one loss in the last 12 years: in 2005, due to the Hurricanes Katrina , Rita and Wilma. This avoidance of loss has resulted in enormous cash flows, handsome earnings, and growing tangible book. Let us, then, take a look at earnings.

Operating History -- Earnings

When we take a bird's eye view of Allied World's earnings, and separate its earnings into averages, we have a table as follows:

(click to enlarge)

The average earnings over the 11-year period above is $326m. Against the current market cap of $3160m, this is an earnings yield of 10.3%. Not bad at all .

Of course, the corporation has grown revenues, so we would be wise to use a shorter and more recent average to better approximate earning power. Check out the recent revenue growth:

Therefore, using the 5-year average earnings of $444m, we would have an earnings yield of 14% -- quite handsome indeed. The 3-year average would be a 15% yield. Therefore, on an earnings basis only, this corporation is already attractive. Since we are talking about an insurer, let us take a look at how Allied has reserved for losses in the past.

Operating History -- Reserves

Allied has historically been more than adequate with its reserving:

(click to enlarge)

( Allied World 2012 10-K, p. 14 )

The loss and reserve development table above is read as follows: "In 2007, Allied World Assurance estimated its loss reserves at about $3,624,872. As of December 2012, Allied World has re-estimated losses downwards, thereby decreasing reserves to $2,326,535. We can then say retrospectively that Allied World had a 2007 reserve redundancy of $1,298,337." In other words, in December 2007, book value would have been understated by some $1.2 billion -- although, we did not know that at the time.

Since the corporation has typically "over" reserved prudently we could hypothesize that they are still currently over reserving. That could mean that the current tangible book value of $2976 (as of March 31st, 2013) is understated. Since the corporation is selling at $3160m (or a price to tangible book of 1.06) it is possible, given the size of past reserve redundancy, that the corporation is actually not at a premium to book but is, assuming future reserve releases , selling at a slight discount to book.

This fact adds to the attraction of this stock, in my opinion. How do our rating agencies view Allied World?

Ratings

It is highly rated:

  1. "A" or "Excellent" at A.M. Best
  2. "A" or "Strong" by Standard and Poor's
  3. "A2" or "Good" by Moody's
  4. "A+" or "Good" by Fitch

Conclusion - Bull Thesis

The groundwork has been laid to be bullish: (1) the company is diversified across business lines, (2) it is selling at a PE-3 of 6 and (3) it is selling at a slight discount to book. But there are a few additional distinctions, which can be made between Allied World and its competitors. For instance, it is in the top of its class when it comes to five-year average operating ROE:

(click to enlarge)

Further, the fact that the business is so near its tangible book represents a backstop should there be a large decline in the share price. And since it is already attractively priced, a fall in price would make the stock increasingly attractive. Many stocks, which offer an earnings yield of some 15%, lack the sort of downside protection, which is offered to some extent here. Allied World is strong, well managed, and cheap relative to earnings.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in [[AWH]] over 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.

See also 6 Reasons To Buy Licensing Giant Iconix Brand Group on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy

Referenced Stocks: AWH , MRH , RE

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