Thursday - February 16, 2006

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Our senior analyst covering the insurance industry, Ann Northrop, CFA, is just starting to see earnings reports in her coverage being released. Are there any surprises so far? And are last summer's hurricanes still casting a long shadow over the industry? We wanted to get her take on this.

Are you still seeing affects of Hurricane Katrina fallout in the property and casualty (P&C) industry?

Yes. All four of last summer’s hurricanes absorbed capital in the P&C industry. Indications now are that pricing has stabilized in many of the hurricane-affected lines, or in some cases appear to be rising. Therefore, I think there are some investment opportunities with some of the reinsurers right now.

Reinsurers have raised their prices, and as a result, primary insurers are increasing their retentions in order to keep their reinsurance costs relatively stable. The reinsurers then move toward higher policy layers with higher, more profitable returns.

There has been some concern among investors lately that some reinsurers have seen premiums decline. But as is the case with Partner Re (PRE), which I've got a Buy on, we think higher margins at the reinsurers will more than compensate for a decline in premiums. PRE, for example, has a strong balance sheet, redundant reserves and a diversified business model. Also, its U.S. business – which accounts for roughly 40% of premiums – we expect will have margins expanding enough to make up for the declines in the company’s European and Asian premium volume and pricing.

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Zacks Equity Research continued...

So would you say reinsurers are the main bright spot in the insurance industry overall right now?

Well first of all, the industry right now is experiencing a deceleration in pricing. Even though this has stabilized somewhat, the industry as a whole is still weakening. But beyond this, I would agree that reinsurers are the one bright spot, mainly because they can increase their prices in the hurricane-affected lines. They then move to higher lines when primary carriers retain more of their own risk.

In Partner Re’s case again, that 40% in domestic premiums should increase in response to higher pricing in the hurricane-affected lines. And PRE is trading at 1.4x book, which is a value given expectations for mid-teens ROE in 2006 and 2007. Also, I’ll just mention here that PRE stock has retrenched since it reported about a week ago. This appears to be because of investors’ concerns over the negative premium growth the company reported in the fourth quarter.

What are your thoughts on life insurance companies these days?

Here I see a bifurcation between large and small life insurance companies. The large companies can take advantage of scale and distribution and grow earnings at a much-faster rate. Prices are up, on average, more than 30% in this group.

So it’s hard to find good values in this area at this time. But Prudential (PRU), even though it’s been up big, is a company we can still see some value in. Prudential is a good company: its international operations are a strong engine of growth, as will be its domestic annuity and retirement programs. This company trades at a premium, but we feel this is deserved. So although the stock has appreciated significantly over the past couple years, we still think it’s a ROE expansion story. PRU’s ROE was 13% in 2005, and its goal is 14% by 2007, though we think they can get there in the next year. Also with Prudential you can expect stock buybacks and increased dividend yields.

So the overall insurance industry is still in a down-cycle. Can you gauge when this might be headed back around?

In terms of cyclicality, P&C I don’t see turning around any time soon. The losses from the hurricanes last summer absorbed lots of capital. Some of that capital has now been replenished through stock offerings, debt, and new companies coming into the industry like hedge funds setting up shop to underwrite business in the hurricane-affected lines. Despite all that, I see price increases in the affected lines and stabilization in other lines. But I see that stabilization as more of a stop on the road to further price declines.

Prices had been rising for quite awhile and were set to come back down. The hurricanes stabilized this decline for a period, but I expect the deceleration to continue in the affected lines, although at a slower rate. How long will it last? That depends on the speed of the decline, like in any cyclical industry. I might be tempted to say two or three years, which would be a normal period, but there’s really no way of knowing.

Ann Northrop, CFA is a senior analyst covering the insurance industry for Zacks Equity Research.

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MORE FROM ZACKS EQUITY RESEARCH...
 

Analyst Blog - NEW!

Get real-time market insights from Zacks Equity Research Analysts. See their latest posts, click here.

 
BULL OF THE DAY

Syngenta AG, ADR (SYT) - Depth of Product Mix. For full Zacks research report, click here.

 
BEAR OF THE DAY

UIL Holdings (UIL) - Dividend Unsustainable? For full Zacks research report, click here.

 
EARNINGS TRENDS

Growth Expected to Slow Sharply in the First Quarter

With over 80% of the results in, it is clear that double digit growth will be achieved for the fourth quarter, but growth is expected to be significantly lower in the first quarter. More...

 
ZACKS INDUSTRY OUTLOOK

Industry Rank for the Week of Feb 6

Fourth-quarter earnings surprises continue to exceeded misses by a margin of 2.4:1. More...
 

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Zacks.com features a free investment simulator where our customers can prove their stock picking skills to the rest of the world. In these articles we will share with you the insights and recommendations from Top Simulator Players. Learn more about the current Zacks Challenge at: http://at.zacks.com/?id=2514.

 
FundAmental

This week Zacks is delighted to introduce Greg Scourtas (aka: FundAmental), another successful contestant who is currently one of the leaders in the Zacks Challenge Simulator competition. Greg has accumulated an overall return of 106% since Jan 3.

This Simulator player is a fan of options and undervalued stocks. Most of Greg’s trades consist of option plays. Some of his recent transactions include options on Southern Peru Copper Corp. (PCU), Google (GOOG), American Standard (ASD), Western Digital Corp. (WDC) and MEMC Electronic Materials, Inc. (WFR). Click here http://at.zacks.com/?id=2515 to check out some of his recent trades.

This market watcher makes his picks based on mostly fundamental and technical analysis. A great deal of Greg’s research and information gathering comes from EDGAR. (EDGAR is operated by the Securities and Exchange Commission and contains regulatory filings for U.S. publicly traded companies). The stock picker stated, “I use fundamental, EDGAR, & technical analysis in that order.”

So what does the Zacks Challenge contender see is his crystal ball?

Greg is not too optimistic. The market enthusiast mentioned that in the next 12 months or so the market will probably experience a slow downward spiral. He provides a host of reasons for his opinion, ranging from 9/11 repercussions to oil prices and supply. Greg believes that, since 9/11, the “big players” are too scared to reallocate bond money to stocks. The Simulator participant also indicated that he does not see oil problems going away. “Demand for oil has passed the earth’s ability to meet it, and it will dwindle sharply soon,” said Greg.

How about advice for those who are new to investing?

The formal financial writer, once again, reiterated the importance of fundamentals and technicals. He also touted gold in this market. Some of Greg’s words of wisdom included, “thoroughly learn financial statements and ratios,” and “study technicals until you figure out the patterns."

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Zacks.com is proud to share with you some of the best trading strategies that truly allow you to Profit from the Pros. Today we highlight...
 

Profit Tracks: Return on Equity

This Profit Track strategy uses Return on Equity (ROE) to discover solid stocks. ROE is one of the quickest ways to gauge whether a company is creating assets or gobbling up investors' cash. This fast moving Profit Track returned an impressive +19.1% in 2005.

Here are four stocks that make the grade for the Recent Price Strength Profit Track:

ADVO Inc.(AD), a direct mail marketing firm, recently posted fiscal first-quarter earnings of 38 cents per share, outperforming last year’s 26 cents and exceeding the consensus estimate by nearly 27%. AD mentioned that it achieved its 14th consecutive quarter of revenue growth on top of 16% growth in the year ago quarter. The company is creating assets as evidenced by its ROE of 25.58. The company’s price to sales ratio is .73. Continue your research on AD at: http://at.zacks.com/?id=2354.

General Cable Corp. (BGC) recently announced fourth-quarter earnings of 29 cents per share, excluding items. The result topped analysts’ expectations by more than 61% and surpassed the year-ago total. The company noted that it achieved its 11th consecutive quarter of positive year-over-year metal-adjusted revenue growth. BGC has an appealing valuation as indicated by its price to sales ratio of .44. General Cable’s ROE is 33.35. Continue your research on BGC at: http://at.zacks.com/?id=2355.

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TIMELY BUY of the WEEK continued...

Brightpoint, Inc. (CELL), which has a ROE of 18.93 and a price to sales ratio of .53, recently reported fourth quarter earnings of 28 cents per share, beating the consensus estimate by about 27% and improving on the previous year’s performance. Brightpoint, Inc. is a leading provider of outsourced services in the global wireless telecommunications and data industry. Continue your research on CELL at: http://at.zacks.com/?id=2356.

FreightCar America, Inc. (RAIL) offers a ROE of 93%, which is currently the highest return on equity figure listed under this Profit Track. The company’s price to sales ratio is .88. RAIL delivered fourth-quarter earnings of $1.38 per share, jumping ahead of the consensus estimate by nearly 27%. The company commented that its strong earnings performance reflects the ability of its management team to increase its production levels while improving productivity. Continue your research on RAIL at: http://at.zacks.com/?id=2357.

To see the full list of stocks that currently pass this winning screen, go to: http://at.zacks.com/?id=2358.

All the Profit Track strategies were created and backtested using the Research Wizard software from Zacks Investment Research. If you like this screening strategy, but want to narrow down the list of stocks and even improve the performance, then you should start a free trial to this powerful stock picking tool. Learn more about the Research Wizard free trial offer and our new special report “Top 10 Stock Screening Strategies” at: http://at.zacks.com/?id=2359.

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SCREEN OF THE WEEK

Creating a Custom Consensus

Kevin Matras combines some of his winningest strategies to create a Custom Consensus screen: http://at.zacks.com/?id=2360.
 

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Here you'll discover a Zacks #1 Rank stock hand selected by Ben Zacks to outperform the market over the next 30 to 90 days. This week's Timely Buy is...

 
Thomas & Betts (TNB)
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Thomas & Betts Corporation (TNB) engages in the design and manufacture of electrical connectors and components used in industrial, commercial, communications, and utility markets worldwide. The company operates in three segments: Electrical; Steel Structures; and Heating, Ventilation, and Air-Conditioning (HVAC). The company sells its products directly, as well as through distributors, mass merchandisers, catalog merchandisers, and home improvement centers.

The company reported an excellent fiscal-fourth quarter earnings report. For the 12 months ended Dec. 31, the company reported 2005 revenues of $1.7 billion, up 11.8 percent from $1.5 billion for 2004. 2005 earnings were $113.4 million, or $1.86 per share, compared to $93.3 million or $1.57 per share in 2004. For the fourth quarter, the company reported net income of $25.8 million, or 69 cents per share, well ahead of the 54 cent consensus estimate.

Management attributed the strong performance to strong sales growth and double-digit segment earnings, as well as the company's ability to get a handle on costs. "We successfully offset higher material and energy costs, further improved operating efficiencies and delivered very strong operating cash flow," said Dominic J. Pileggi, Thomas & Betts chairman and CEO, in a statement.

TNB's management has shown that it is determined to reduce debt as well as increase cash flow. The company generated $157 million of free cash flow in 2005, which gives it more latitude for share buybacks or increased dividends. TNB also retired $150 million in debt, and ended the year with a debt/total capitalization of 27%, which is quite manageable.

Over the past 90 days, 2006 estimates have increased 9.9% to $2.45 per share. The company has exceeded estimates in each of the past five quarters by at least 9%. Despite the stock's excellent recent performance, it is still attractively valued at 16.6x next year's estimates. This is slightly above the company's long-term growth rate of 15%.

OTHER TOOLS FROM ZACKS

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At the heart of Zacks Investment Research is the Zacks Rank investment philosophy that continues to vastly outperform the market. Our Zacks #1 Rank (Strong Buy) List has produced the following results for investors:

• +32.5% average annual return since 1988 versus +11.8% for S&P 500
• Outperformed S&P 500 in 17 of the last 18 years
• +43.8% total return from 2000 to 2002 - the worst bear market in over 60 years.
• +18% in 2005

And just as importantly, our #5 Ranked stocks (Strong Sells) have alerted investors as to which stocks to dump from their portfolios to avoid unnecessary losses.

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• Broker Recommendation changes
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We hope you enjoyed this issue of "Profit from the Pros", And we look forward to visiting with you again next week.

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Regards and Happy Investing,

Charles Rotblut, CFA

Senior Market Analyst
Zacks.com

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