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On Jul 11, we downgraded our recommendation on Hilltop Holdings Inc. (HTH - Analyst Report) to Neutral. While the recent PlainsCapital acquisition has boosted results thus far, persistent weakness in the insurance operations and the recent rating downgrades raise caution.

Why the Downgrade?

On May 6, Hilltop reported first-quarter 2013 operating earnings per shareof 39 cents and revenues of $280.5 million. The results surpassed the Zacks Consensus Estimate for earnings of 31 cents and revenues of $273 million. In addition, both earnings and top line exceeded the year-ago results of 1 cent per share and $38.1 million, respectively.

Higher premiums, deposits, interest and non-interest income along with lower-than-expected underwriting and other expenses drove the remarkable upside. These factors led to an improvement in improved combined ratio.

Post the first quarter results, the Zacks Consensus Estimate for 2013 remained static at $1.39 a share, while it climbed 5.1% to $1.43 per share for 2014, over the last 60 days. Consequently, with the Zacks Consensus Estimate for 2013 and 2014 depicting slight upward pressure on the stock in the near term, Hilltop now has a Zacks Rank #2 (Buy).

Cause for Caution

Following the acquisition of PlainsCapital, Hilltop has been able to amplify its operating and competitive efficiencies through diversification. A risk-free balance sheet and strong cash flow also bode well for the improving financial adequacy.

Despite registering extraordinary growth in the last two quarters, investors remain skeptical due to the lack of comparable growth parameters in the previous years. Based on this, the company expects growth to be moderate going forward.

Moreover, Hilltop’s insurance operations appear to have taken a backseat amid the recent operational changes. Significant price and product competition along with a weak property-casualty market are hampering results. The recent rating downgrade from A.M. Best further raises our concern.

Other Stocks to Consider

Apart from Hilltop, other stocks that are outperforming in the insurance sector include American Safety Insurance Holdings Inc. , AmTrust Financial Services Inc. (AFSI - Snapshot Report) and HCI Group Inc. (HCI - Snapshot Report). All these stocks carry a Zacks Rank #1 (Strong Buy).

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