Universal Insurance Holdings (UVE) operates as an integrated insurance holding company that offers customers a variety of products, including:
- Homeowner’s insurance
- Renter’s insurance
- Condo unit owner’s insurance
They offer services across the insurance value chain with a focus on the end-market.
The stock is not low risk, primarily due to the business’ biggest risk and headwind: hurricane and tropical storm damage due to their policy concentration in Florida.
At the same time, there is a lot to like about the business:
- Competitive Advantages In Florida That Drive Its Strong Organic Growth
- A Stellar Balance Sheet
- An Impressive Track Record
- Lengthy Growth Runway
4 Reasons To Like Universal Insurance
1) Strong Competitive Advantages In Florida
UVE enjoys cost, financial capacity, network, and service advantages in Florida that have helped to drive its very strong organic growth in the state that has made it the number one provider of P&C insurance in the state.
Its cost advantages stem from aggressive underwriting (which has its cons as well – more on that later), scale, and selling through agents instead of using intermediary offices. As a result, UVE is rated as one of the cheapest home insurers in Florida with an average annual premium of $1,487 for $214,000 of coverage, despite operating in some of Florida’s most Hurricane-prone markets. Meanwhile, Florida’s average is $1,727.
Its financial capacity advantage stems from its extremely low debt burden and high reinsurance capacity and enables it to attract customers who want to be sure that their home insurance provider will actually be able to deliver on their obligations in the event of a major catastrophe such as a huge hurricane slamming Florida.
Their network advantage stems from their position as the number one insurer in the state with 10.5% market share. As a result, their name brand is strong and they benefit a lot from word-of-mouth recommendations alongside their army of ~10,000 sales agents who work on the ground to promote the brand.
Last, but not least, their customer service advantage stems from their investments in IT and vertical business structure which enables them to provide end-markets across the insurance value chain. As a result, they are able to pay and dispute policy claims faster than most competitors and are able to provide highly accurate quotes to potential customers very quickly. These capabilities combine to generate high customer retention rates and also makes UVE the best-reviewed home insurance company in Florida according to ValuePenguin.
2) Stellar Balance Sheet:
UVE also has a very strong balance sheet, earning an ‘A’ (exceptional) rating from Demotech for financial stability for the following reasons:
- A very strong reinsurance policy that includes first-event capacity of ~$3.4 billion in all-states.
- A miniscule debt-to-equity ratio with no preferred equity
- Very conservative total assets to total liabilities ratio
- Significant cash and overall liquidity on hand
3) Impressive Track Record:
UVE’s competitive advantages in its core Florida market has enabled it to generate an impressive track record of organic growth while simultaneously fortifying its balance sheet.
The business has generated an average ROE of 18.5% and compounded book value at an 8.9% CAGR over the past 5-years, both of which are quite impressive, especially given the weather headwinds that the company has faced and the substantial dividend that it pays out.
Additionally, UVE is a free cash flow machine, throwing off $858 million of FCF over the past half-decade (more than double its current market cap of $420 million).
Furthermore, until its recent share price plunge UVE was absolutely crushing the S&P 500 (SPY) and has still beat it over the course of its history:
UVE is also a dividend growth stock that deploys a prudent strategy of paying out a set amount per quarter (currently $0.16) and then pays out an end-of-year special dividend (currently $0.13) in conjunction with its Q4 dividend.
As a result, investors can count on a very safe quarterly payout that should be sustainable regardless of weather patterns that year along with a “bonus” (but really quite steady as well given that it has been paid out in heavy storm years) dividend at year-end. This leaves flexibility for management, while still giving investors considerable income.
4) Lengthy Growth Runway:
The business appears poised to continue its strong growth and equity compounding for a long time to come.
In its latest earnings report – Q3 FY2021 – UVE reported strong results:
- Direct premiums earned increased by a very strong 15% thanks to primary rate increases in Florida, which is very important as it improves the company’s risk-reward profile for its Florida underwriting. In Q3 the company received an approval for a 14.9% Florida primary average rate increase for UPCIC.
- The company benefited from decreased weather events year-over-year and also management business expenses effectively. As a result, the company managed to generate an annualized return on average equity of 16.4% during Q3, which is remarkable given that Q3 is often the least profitable quarter for the company given that it takes place during a large portion of hurricane season. As a result, the company maintained its guidance for earnings-per-share to come in between $2.75 and $3 for the full year, which implies an extremely low P/E ratio of ~5.2x at the midpoint of guidance.
- Management continues to take a conservative approach to capital reserves and is deploying much of its retained cash flow towards shoring up capital reserves across the business. While this is great from a risk mitigation perspective, the disappointing part of it is that the company only repurchased a paltry $1.4 million of shares during Q3 even though the share price was very cheap and traded at a significant discount to book value.
- Best of all, management highlighted that current results do not fully reflect the significant rate increases that the company has achieved in Florida over the past year – and in particular the 14.9% UPCIC rate increase in Q3 – as the rate is always a laggard by 12 months within the business. As a result, the next 12 months should see results at UVE materially improve.
We fully expect UVE to maintain this growth momentum as they continue to leverage their competitive advantages to grow their positioning in Florida and accelerate their penetration of other states with less weather risk (and thereby increasing the quality of their earnings).
Increasing the quality of their earnings will also prove to be a boost to earnings growth as it will enable them to invest more of their retained earnings and float into riskier and higher-returning asset classes. For now, they are being very conservative with their investment book (average investment is an A+ rated corporate bond) since they want to maintain a stellar balance sheet against any potential natural disasters in Florida.
Management reported on a recent earnings call that:
The Florida market, as we’ve commented briefly, it’s hardened. We see a lot of competitors that are pulling out of specific areas around the state. Our philosophical approach to rating has never been to rate the competition, but to rate to adequacy. So we now find ourselves writing around the state in areas that traditionally, we did not, in areas where friends of ours, agents of ours that we knew well, could not write because we were double or as much as triple the premium of some of our competitors.
So as that has changed, our ability to organically write and underwrite our own policies is considerable, and we like the growth. I think our reinsurance partners will like the growth because it is outside of Tri-county. And as we continue to balance our portfolio, we feel as though that is a considerable opportunity for us going forward.
Mechanics in the state, as we continue to aggressively handle our claims, we are experimenting and continue to use products we’ve used for 2 or 3 years. Many insurers are more welcoming of our ability to adjust or adjudicate a claim remotely, rather than having to send them in.
2 Reasons Why Mr. Market Doesn’t Like UVE Stock
1) Hurricane Risks:
Given that a little over 80% of UVE’s premiums come from Florida, hurricane risk continues to loom large. Over the past several years in particular, we have seen a surge in storm activity that has significantly eaten into UVE’s profitability. This not only causes the loss ratio to go up, but also drives up reinsurance costs in the state.
As management pointed out on their Q3 2020 earnings call:
We continued to see headwinds in the third quarter as we dealt with elevated industry-wide weather events year-to-date, particularly in coastal states.
As previously announced, we were affected by full retention events from Hurricanes Isaias and Sally in addition to other PCS events year-to-date. As the Statute of Limitations for Hurricane Irma approach is ending, we experienced increased prior year companion claims, as the window closed. This increase in claims led us to increase our reserves in years prior to 2020.
One of the biggest hits to UVE in recent years has been their forced increase in reserves due to the escalated costs from major storm events such as Hurricane Irma.
2) Low Interest Rates:
This is no secret and is impacting the entire insurance industry. However, what it means is that insurers either have to take more risks in investing their float (thereby putting their solvency at risk) in search of greater profitability, or they have to settle for lower profits.
We think UVE has been prudent – given its high concentration in Florida – to invest float conservatively. However, when combined with high combined ratios in storm-filled years, their extremely low investment yields squeeze their profitability tighter and tighter.
If UVE wants to return to compounding investor equity at high rates, it must either quickly diversify into more conservative regions (enabling it to take on more risk with its investment float), pray that interest rates rise meaningfully soon, and/or pray that recent hurricane activity subsides in the coming years.
UVE is not a low-risk stock by any means given the troubling increases in hurricane activity in Florida. Additionally, historically low interest rates combined with UVE’s need to maintain a large and strong balance sheet make it very difficult for the company to generate strong investment returns.
However, even during one of the worst years on record in 2020, UVE was still able to generate a low-teens ROE and slightly grow book value. With a stellar balance sheet, plenty of room to grow and diversify the business, strong competitive advantages in its core market, a good track record of profitability and growing book value through weather cycles, an attractive and growing dividend yield supported by buybacks, and a deep discount to book value, UVE looked very attractive to us as we headed into 2021 and the company’s profitability strongly rebounded on improving premiums in Florida, reduced fraudulent claims thanks to new legislation from Florida’s legislature, and a decline in severe weather incidents. Now, with interest rates appeared poised to increase alongside soaring inflation and the housing market remaining robust, especially in Florida, UVE has a lot going for it.
That said, we decided to sell the stock after its recent run-up anyway.
UVE was a great investment for our Core Portfolio. We opened the position on a value basis and generated a 40.1% total return (36.62% annualized return) and then substantially enhanced our annualized return by averaging down consistently through the year as the stock fell on fears related to the hurricane season and persistently low interest rates. This led to us generating an average annualized return on our investment of 69%.
We were happy to do so because the yield was high, the balance sheet was stellar, and the growth and ROE were strong, so we had confidence that eventually market sentiment would shift and we would make a nice profit. Sure enough, as the storm season passed, and the interest rate environment increasingly pointed towards rates rising in 2022, UVE shares took off.
While we still like the company a lot and think it should generate solid long-term returns even from the current share price, it is no longer trading at much of a discount to our Buy Under Price with only ~3% further upside at the price we sold at.
Furthermore, in our recent exclusive interview with UVE, management stated that they have no plans to increase the dividend anytime soon and are building cash reserves to strengthen the company’s balance sheet instead of pouring it into buybacks or acquisitions. As a result, we see little catalyst beyond interest rates to propel shares higher for the foreseeable future, so we would rather invest in other more undervalued and higher yielding insurance businesses and wait for the stock to potentially drop later this year once storm season hits before buying back in.
As a result, we decided it was a prudent time to exit the position and recycle the capital into another very attractive looking opportunity. We will keep our eye on UVE shares moving forward and will not hesitate to buy back in if shares plunge on hurricane fears later this year.