Harleysville Group Inc (HGIC) Dividend Stock Analysis

Summary

-Harleysville Group Inc. (HGIC) is primarily an insurer of small businesses that operates in 32 states.
-Revenue growth has been less than 1% annually over the past 5 years, but earnings growth has been 13%.
-The dividend yield is currently close to 4%.
-The dividend has grown by 13% annually over the past 5 years.
-The P/E is under 11 as of this writing.
-I think HGIC would make a fairly conservative yet profitable investment under $35 per share.

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Overview

The premise behind an insurance company is that they spread risk out over a wide number of people and businesses. They collect premiums (payments) from clients and in return those clients are covered in case of a serious loss. From an insurance business standpoint, it’s ideal to collect more in premiums than you pay out for losses. This is not the primary form of earnings, though. An insurance business, after collecting all of the premiums, holds a great deal of assets that, over time, are paid out for client losses. An insurance company constantly receives premiums and pays out for losses, so as long as they are prudent with their business, they get to constantly keep this large sum of stored-up assets. As any investor reading this knows, a great sum of money can be used to generate income from investments, and that’s how an insurance company really makes money. HGIC invests its stored up collection of assets (approximately $3.3 billion in assets) primarily in fixed income securities, some of which are tax exempt.

The company consists of a collection of smaller, regional insurers under a common brand and a common risk pool. This means that HGIC’s companies benefit from the economies of scale that the larger company provides but also are streamlined and small to efficiently operate in regional markets. This also means that most of the businesses under the HGIC brand have a shared risk pool meaning that they spread out liability among their businesses.

HGIC primarily writes insurance for small and medium businesses (80% of premiums) but also has personal insurance business (20% of premiums). Industries range from car insurance to flood insurance to worker’s comp.

Revenue, Earnings, Cash Flow, and Margins

HGIC, though conservatively run, has grown shareholder value substantially over the past 5 years.

Revenue Growth

Year Revenue
2009 $980.6 million
2008 $985.3 million
2007 $962.0 million
2006 $999.2 million
2005 $948.3 million
2004 $953.4 million

Revenue includes premiums written and investment income. Revenue has had slow growth of less than 1% annually over the past 5 years.

Earnings Growth

Year Earnings
2009 $86.3 million
2008 $42.3 million
2007 $100.1 million
2006 $111.1 million
2005 $61.4 million
2004 $46.9 million

Net income has grown by about 13% annually over the past five years.

Book Value Growth

Year Book Value Per Share
2009 $27.98
2008 $23.18
2007 $25.03
2006 $22.49
2005 $20.07
2004 $19.47

Book Value is a fairly important metric for valuing an insurance company’s stock. Book value per share has increased at an annual rate of over 7% over the past 5 years.

Dividend Growth

HGIC is soon to become a dividend aristocrat. The company has grown its dividend for 23 straight years, and is currently yielding nearly 4%.

Dividend Growth

Year Dividend Yield
2009 $1.25 4.03%
2008 $1.10 3.05%
2007 $0.88 2.80%
2006 $0.73 2.35%
2005 $0.69 3.28%
2004 $0.68 3.40%

Over the past 5 years, HGIC has increased its annual dividend by approximately 13% annually. As can be seen from the table, the dividend yield is close to its high point of the past 5 years, and the stock largely missed out during the 2009 market rally. This presents a good value in my opinion.

Share Repurchases
Over the past 3 years, HGIC has repurchased approximately 17% of its market cap worth of stock.

Balance Sheet

HGIC holds a conservative balance sheet. As previously mentioned, an insurance company makes a lot of its earnings by generating income on its common pool of held money. Harleysville Group Inc holds most of its money in rated A investments.
41% of portfolio assets are held in Aaa rated investments.
43% of portfolio assets are held in Aa rated investments.
14% of portfolio assets are held in A rated investments
Only 2% of portfolio assets are held in investments rated below A.

Investment Thesis

HGIC is currently undervalued compared to both the broad market and their historic valuation. This is a difficult time for insurance companies, but HGIC is well-run and owns a conservative portfolio allowing it to weather the storm. Unlike many other insurers, HGIC has not reported any losing quarters in 2008 or 2009 and has continued strong dividend increases throughout the economic crisis while other insurers cut dividends or raised them a minuscule amount.

When looking for an insurance investment, my search came down to two companies: HGIC (Harleysville Group Inc) and CINF (Cincinnati Financial Corp). CINF pays a 5.5% dividend yield and is similarly valued to HGIC in terms of earnings multiple. Analysts are significantly more bullish for HGIC going forward. CINF was hit harder by the economic crisis in terms of both magnitude and duration. CINF’s investment portfolio is less conservative compared to HGIC with at least 34% of their portfolio consisting of investments rated below A compared to HGIC’s only 2% of investments rated below A. Most importantly for me, although HGIC has a lower dividend yield (4% compared to 5.5%), their latest dividend increase was a solid 8% compared to CINF with a less-than 1.5% dividend increase. HGIC also continued share buybacks (although at a reduced level) through 2009 whereas CINF bought back no shares in 2009. HGIC is approximately one fifth of the size of CINF.

It can be difficult finding value stocks in this market. The market rally over the past year has brought the average stock valuation over the historical average, but the rising tide did not lift all boats. There are still values to be found, and I believe HGIC is one of them. CINF is also worth a look, but at this time I’m more confident in HGIC.

Risks

As an insurance company, HGIC’s business is all about managing risk. Compared to many other insurers, HGIC is rather conservatively managed. Their revenues have grown slowly and their investments are primarily high quality investments with reduced return and reduced risk. Their businesses use a common pool to spread risk out among the company. Overall, although the insurance business is a bit dicey at the moment due to difficult economic conditions, I consider HGIC to be a relatively conservative stock pick. Their dividend is well-covered, and most of the returns of this company have been in the form of dividends and share repurchases. HGIC was profitable during the worst of the recession in 2008, but was clearly hit hard as their income dropped to less than half of 2007 levels. If the economic recovery takes a turn for the worse, insurances companies like HGIC will be hit hard again. As an insurer of small businesses, HGIC benefits when small businesses are growing.

Conclusion and Valuation

Overall, with a P/E of under 11 and a dividend yield of nearly 4%, I consider HGIC to be a good long-term value income stock. I don’t expect amazing returns, though I do expect very solid risk-adjusted returns, continued dividend growth, and share repurchases on top of slow business growth. I think the stock is attractive under $35.

Full Disclosure: I own shares of HGIC
You can see my full list of individual holdings here.

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Comments

  1. What a great resource!

  2. Thanks for another interesting analysis. What is your view on Hudson City Bancorp?

    2009 was it eleventh year of record profit and it has been growing its dividend for 10 years+. It seems like a conservative company, as one analyst put it: “Hudson stuck to its conservative lending practices and skipped subprime mortgages, trading short–term windfalls for slow but steady growth. ”

    Dividend yield is about 4,8%
    Current PE is 11,4
    Revenue and Profit growth (2009 vs 2004) has averaged at about 20%.

  3. defensiven,

    HCBK has caught my eye a bit in the past due to its low valuation and high dividend, but so far I haven’t really taken the time to crunch the numbers on the company. I feel that I am more knowledgeable about insurance companies than banks, so I analyze more of them.

    One thing I noticed is that apparently HCBK did not increase their dividend this year so far, despite having the earnings to do so.

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