-Chubb (CB) is an international property and casualty insurer.
-Revenue has been static over the most recent five year period.
-Five year average net income growth has been 7%.
-Five year book value growth has averaged over 12% annually.
-Five year dividend growth has been over 11%.
-Current yield: 2.60%
-Shares seem attractive at current prices, with a P/E of under 9.
Chubb (CB) was founded in 1882 as a marine underwriting business in New York, and now exists as an international property and casualty insurance company with over 10,000 employees.
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. Chubb, however, is adept at ensuring that their premiums exceed their payouts, so compared to many other insurers, Chubb receives significant income from their underwriting businesses.
Chubb has three business segments, and the executives expect an underwriting profit from each of them.
This segment accounted for $4.7 billion in premiums in 2009, representing 42% of the total. Insurance products are offered for casualty, peril, workers compensation, property, and marine.
This segment accounted for $3.7 billion in premiums in 2009, representing 33% of the total. Insurance products are offered for fine homes, automobiles, and possessions.
This segment accounted for $2.7 billion in premiums in 2009, representing 25% of the total. Insurance products are offered for specialty professional liability for companies, institutions, firms, and healthcare organizations.
24% of Chubb’s total premiums come from outside of the United States. The company holds offices in 27 countries, and on continents including North America, South America, Europe, Asia, and Australia.
Revenue, Profit, and Equity
Chubb receives revenue from premiums written, in addition to income earned from investments and a few other areas.
|Year||Premiums Earned||Investment Income||Other Sources||Total Revenue|
|2009||$11.331 billion||$1.585 billion||$100 million||$13.016 billion|
|2008||$11.828 billion||$1.652 billion||($259 million)||$13.221 billion|
|2007||$11.946 billion||$1.622 billion||$539 million||$14.107 billion|
|2006||$11.958 billion||$1.485 billion||$560 million||$14.003 billion|
|2005||$12.176 billion||$1.342 billion||$565 million||$14.083 billion|
|2004||$11.636 billion||$1.207 billion||$334 million||$13.177 billion|
Premiums earned have diminished by an average of 1% annually over these five years. Investment income has grown by over 5% per year on average during this period. The overall result is that total revenue has remained virtually static for 2009 compared to 2004. Premiums are on track to be relatively static or modestly down throughout 2010 as well.
Income has been fairly erratic due to this recession. Over this five year period, the average income growth has been 7%. EPS growth is even bigger due to share repurchases.
|Year||Total Shareholder Equity||Book Value per Share|
Total shareholder equity for the company has increased by an average of over 9% annually over this five year period. Equity per share, or book value, has increased by an average of over 12% during this same period. Book value has increased faster than total shareholder equity because the company has been repurchasing its own shares, and therefore the total shareholder equity is divided over a continually smaller number of shares in existence.
Chubb has increased its dividend for 45 consecutive years and has a payout ratio of under 30%.
Over this six year period, the company has grown dividends by an average of over 11% annually. This chart takes into account a stock split and also projects 2010 data based on the current quarterly dividend.
Chubb’s Property and Casualty Finance strength has been given an AA rating by Standard and Poor’s, and comparable ratings by other agencies.
Combined Loss to Expense ratio was reported to be 86% in 2009, which is excellent.
Chubb has a business model that is slightly different than some other insurers. The premiums they charge tend to be a bit high, but they typically offer superior claim service. Management insists on a culture where the company does not chase premium growth at the expense of having to under-charge on insurance products. The company conservatively allocates its resources, and has weathered mass asbestos claims, hurricane Katrina, and the economic crisis of 2008.
And then there’s the topic of share buybacks- an important aspect of this investment. There exist debates on whether share repurchases are useful for creating shareholder value, and of course like just about any other debate topic, the answer is that it depends on the unique situation. Some companies are poor at using share repurchases to create shareholder value. They buy their shares when they are highly valued and cash is flowing, but then reduce or eliminate their share repurchases during times when the economy is tough, cash is scarce, and their stock is cheap. This is the exact opposite of what a shareholder wants.
Some companies, on the other hand, use share repurchases effectively. They pay dividends to shareholders, and use excess capital to repurchase shares. They constantly repurchase shares, meaning they dollar cost average into their own company, and/or they specifically focus on repurchasing shares during times of economic uncertainty when their shares are at the cheapest in terms of P/E. A lot of insurers, including Chubb, fall into this category. Some insurance company valuations tend to be fairly low, and their price-to-book (P/B) ratios tend to be close to 1. Chubb has been repurchasing its own shares for several years, and is currently purchasing them while the P/E is under 9 and the P/B is 1.17. Their 2009 annual report describes their reason for doing this. Chubb’s investment portfolio mainly consists of fixed income producing securities, and with interest rates so low, returns from this type of security are currently poor. Chubb management has decided that the best use of excess capital is to repurchase their own cheap shares. This mindset puts Chubb into a position where they tend to look favorably on share repurchases during times of economic uncertainty, meaning they act in the exact opposite way of companies that have poor share repurchase timing.
At the end of the fourth quarter of 2006, Chubb had approximately 428 million shares outstanding. The most recent quarter in 2010 (second quarter) reports that the number of shares outstanding is approximately 314 million. Chubb has repurchased over $1 billion worth of its own stock each year since at least 2006. This means that the company earnings and dividend payments are divided over an increasingly smaller number of shares, and so EPS and dividends per share grow at an attractive rate despite static business operations producing little or no growth. With the low P/E, the company can purchase many shares for their money, and dividend growth can lead to great returns for shareholders.
The net result is that this seems to be a good business at a low price. Company-wide revenue declines make this company look unattractive, but equity growth and income growth balance this out, and share repurchases that lead to EPS growth and dividend growth make the investment very worthwhile. All this company has to do to increase dividends and EPS is to maintain the current trend. Any growth is icing on the cake.
The company has stated that they focus primarily on bottom line growth; profitability. They look to boost premiums where possible, but not at the expense of profitability. Their business model has been summed up as follows by the son of the founder of the business:
The way to success is to select good risks and cover them. Obviously this does not lead to great size, but it should produce profitable business.
-Percy Chubb, 1857-1930
By offering great claim service for slightly higher premiums, the company hopes to be looked upon as the select company in their various niches. This is working quite well for their Masterpiece policy, which is an insurance product for the affluent.
Still, I’d like to eventually see some top-line premium growth for the company. This would show that they have a decent economic moat. Company management has referred to the bailouts of their financially troubled competitors as “troubling”. Some companies that chase premium growth, or hold riskier balance sheets, have been bailed out by the federal government, while prudently managed companies like Chubb have not needed bailouts. One could argue that his encourages businesses to play a riskier game, and can affect the growth of the more conservative and responsible businesses.
Chubb management’s current advertising focuses on the fact that insurance is not a commodity. It’s not just something that you need to have, and look for the cheapest price to attain it. “Who insures you doesn’t matter. Until it does.” is one of their slogans, attempting to draw client attention towards their exceptional claims service and financial strength. While this strategy has given shareholders great returns, time will tell if this business model of higher premiums and better service continues to be effective. The truth is, although insurance businesses are simple and profitable, it can be extremely difficult to develop a significant economic moat because insurance really is viewed as a commodity in most cases. Companies battle to provide a nearly identical product, and the customers only find out about the differences on the rare occasion that they have to file an insurance claim.
All companies face risk. Insurance companies are businesses about reducing risk and spreading it out, and they even insure their own operations against risk. Chubb faces the risk of a continued difficult economy, as well as catastrophic losses. In addition, since they are an international insurer, they face currency risk. A less tangible risk is their modestly falling premiums. An eroding competitive advantage must be avoided.
Conclusion and Valuation
In conclusion, Chubb looks like a solid dividend growth investment at current prices. Management seems quite adept at investing and building value, but time will tell whether they can grow their market share, boost profits, and improve premiums earned. Chubb can grow its dividend and EPS despite static company-wide results due to its continual repurchasing of its own cheap shares. With a strong balance sheet, good earnings, prudent management, and growing dividends, this represents a good way to add some conservative financial exposure to a portfolio. The low P/E of under 9 combined with the strong financial condition of this business and their long history of consecutive dividend increases provides a sturdy margin of safety.
Full Disclosure: I own shares of Chubb at the time of this writing.
You can see my full list of individual holdings here.
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