Market Thoughts
Links | Sitemap | Search:   
  Home  > Commentary  > Archive  > Individual Stocks  

Bill Rempel on Donegal Group

(Guest Commentary by Bill Rempel June 14, 2007)

Dear Subscribers and Readers,

As we are sending this, both Goldman Sachs and Bear Stearns are now trading 2% below their closes in pre-market trading this morning after earnings that showed a weakening bottom line with both their mortgage and hedge fund businesses.  Much of the weakness was caused by the continued deterioration of the subprime sector (the latest spike in long-term yields will continue to have a lingering effect on both the housing and the mortgage sector as well).  The latest earnings deterioration at both Goldman and Bear Stearns is an ominous sign for the stock market, especially given the continued deterioration of liquidity in our financial markets today, due to:

  1. Central banks around the world continue their hiking cycles

  2. The latest spike in yields is causing difficulty with many private equity investors in raising the necessary amounts for their LBOs.

  3. The summertime is traditional a period of low liquidity not just because of lower trading volume but also because of less insider buying during this time as well.

Without further ado, I now want to present our monthly guest commentary from Bill Rempel.  For those who would like to learn more about certain individual stocks and how to pick them, I have again ask Bill Rempel (of one of our regular guest commentators to write a commentary for us.  Let us now begin will Bill's commentary.  In this commentary, Bill will be discussing his thoughts on Donegal Group a 100-year old insurer focusing on its line of businesses, risks, and valuations as well as technicals.  Without further ado, following is a biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see Bill Rempel on Bon-Ton Stores for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

You hope your insurance company will be "there when it matters most."  Being in the industry, I'm somewhat cynical about that tagline, which belongs to this month's company, the Donegal Group (DGICA).  I am really just hoping they'll be "there with a rising share price."  I have got some thoughts on why that seems likely to me. 

The 100-year history of the company sounds impressive at first, until you temper it with geography; one century is a long time for an insurer out of Texas, unthinkable for a Bermuda company, but not that long for an insurer out of Marrietta PA, and the blink of an eye for an insurer out of London.  That's not to say 100-year-old IA (independent agent) insurers can't fall behind the times and fade into obscurity, either, especially if they can't handle change well.  Seibels Bruce and Confederation Life, are your ears burning?

On our "handling change well" checklist, you could pay your premium or file a claim online with Donegal Group.  If you don't have a policy yet, you could find an agent online, searching by distance from your address or looking by zip code.  To the spoiled kids today, used to things so easy a Cro-Magnon Man could do them, this is hardly cutting-edge stuff, but unless you've worked it, you have no idea how strange it is to see a 100-year-old domestic small-cap insurer with this kind of stuff on the web.

Their portfolio of products includes homeowners, auto, dwelling, boat, and umbrella on the personal side, and tradesman's, BOP (retail and wholesale), auto, umbrella, package and workman's comp on the commercial side.  They also offer farm products, including umbrella, a testament to their heritage as a farmers' mutual company. Some of their recent expansion in the southeast comes at the expense of Vesta and their Texas Select fiasco, through a purchase of Shelby's renewal rights.  Shelby's changed hands a couple of times, I can remember when but I digress.

The company was 63% personal lines in FY 2006, with 41% in private passenger auto and 18% in homeowners, and 3.5% "other."  This is a good mix in my opinion, because auto is a line of business marked by stable combined ratios from year to year and a limited exposure to natural disaster.  In the 37% of the book that is commercial lines, 11% is commercial auto and another 11% is workers' comp, with the remainder in commercial multi-peril and 1% "other."  I like auto as a line for insurers, and work comp generates some hefty investment income per premium written, so this mix of business is pleasant.  Donegal is a fairly heavy user of reinsurance, purchasing 100% of $80 million in catastrophe cover excess of $3 million, and an assortment of excess of loss coverages by line.  This has the net effect of smoothing results from year to year, limiting the odds of a windfall but lessening the risk of ruin.  Not a bad thing.

They do have a bit of an option overhang, about 3% dilution.  Something to think about.

Last year, investment income equated to 6.9% of total written premium and a 3.61% return on total investments, with 95%+ of those gains coming from fixed maturities.  Donegal's investment book is primarily munies, followed by treasuries, with mortgage-backed securities a distant third, and corporate debt and equities coming in last.  Boring, which is nice in an insurer's portfolio.

Despite the long history as a company, they've only been public for six years, IPOing after a series of acquisitions and restructurings in the early part of this century.  They've traded from $5 to $21, but $15 and $13 look like key support to me. 

Donegal Group (DGICA)

Here's a close-up of the action recently.

Donegal Group (DGICA)

AM Best gives them an "A" rating, but that's not a guarantee of anything, as I've seen companies go from "A" to "D" in record time.  You know who you are.  But back to Donegal, they have had only 2 unprofitable quarters in the last 8 years, with a nice pattern of growth in the book value, the revenue stream, and generally in earnings as well.  The reinsurance commitment and conservative portfolio of investments are probably to credit for the smoothness of earnings.

The growth is part of what attracted me to the stock in the beginning.  The annualized 5-year revenue growth has exceeded the industry's (12.25% versus 11.24%), as has the annualized 5-year book value growth (11.33% versus 10.36%), cash flow growth (44.00% versus 33.91%), and EPS growth (34.25% versus 32.31%).  Book value has grown about 8% annualized over the last nine years, and this is a book that carries NO intangibles or goodwill on the asset ledger.  Of course, the reason it's a "value" today has to do with a recent stumble in growth, which can sometimes be a signal of a "fallen angel" type of stock.  In their news release, they blamed the drop on increased claim activity caused by harsh winter weather.

The valuation metrics compare favorably to the industry average as well.  The TTM metrics, all below the average for the industry, are: P/E of 10.60, P/B of 1.20, P/S of 1.14, P/Cash Flow of 9.69, and a PEG of 1.32.  This is not dirt cheap, except maybe for that price-to-no-intangibles-book value, but it's cheap.

From downloading the financial statements, here are some data of interest:

REVENUES n/a 5.5% 33.9% 11.1% 3.2% 0.7%
INCOME n/a 52.5% 72.7% 16.9% 8.8% -9.0%
ASSETS n/a 20.1% 22.2% 6.3% 6.4% 0.8%
LIABILITIES n/a 6.9% 25.2% 2.2% 1.5% 0.0%
EQUITY n/a 56.7% 16.3% 14.5% 15.4% 1.9%
TANGIBLE EQUITY n/a 56.7% 16.3% 14.5% 15.4% 1.9%
DILUTION PERCENTAGE 1.2% 3.3% 3.5% 3.1% 2.3% 1.6%
DILUTED EPS 0.73 1.01 1.26 1.44 1.54 1.40
DILUTED OCF 2.06 1.70 1.35 1.91 1.29 1.20
DILUTED FCF 2.25 2.00 1.87 2.31 1.74 1.60
DILUTED DIVIDEND 0.21 0.21 0.24 0.27 0.30 0.32
DILUTED BOOK 8.06 11.47 9.66 10.85 12.25 12.53
PERCENT INTANGIBLE 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
LONG TERM DEBT / OCF - 0.83 0.91 0.63 0.92 0.99
LONG TERM DEBT / FCF - 0.71 0.66 0.52 0.68 0.74
LONG TERM DEBT / EQUITY - 0.12 0.13 0.11 0.10 0.09
INTEREST / OCF 3.3% 4.2% 4.7% 4.6% 8.3% 9.2%
INTEREST / FCF 3.0% 3.6% 3.4% 3.8% 6.1% 6.9%
DIVIDEND / FCF 9.4% 10.7% 12.8% 11.5% 17.1% 20.3%
EARNINGS QUALITY 2.25 1.47 1.05 1.22 0.89 0.90
CASH GENERATING POWER 1.39 0.33 0.85 1.03 1.05 1.13
RELIANCE ON FINANCING CASH -1.2% 11.1% 1.6% 0.7% 0.8% 0.6%
INVENTORY / REVENUE 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
ACCT REC'L / REVENUE 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
ACCT PAY'L / REVENUE 1.0% 1.1% 0.0% 0.3% 1.0% 1.1%

I have a current position in Donegal Group (DGICA) based on the analysis above.  At this point, I believe it's a stock that presents value for the price.

Article Tools

Subscribe to this FREE commentary

Discuss this page

E-mail this page to your friends

Printer-friendly version of this page

  Copyright © 2010 MarketThoughts LLC. | Privacy Policy | Terms & Conditions