Fair Multiples for State Auto

Fourth quarter 2007 earnings were ahead of expectations following benign weather and positive prior accident years reserve releases. Even though State Auto Financial Corporation (STFC - Snapshot Report) has had a long track record of superior underwriting and financial performance, growth trends have been under attack from intensifying competition, in addition to upward pressure on the company's loss ratios. Therefore, we expect earnings growth and ROE to moderate. With few upside catalysts to the shares of this company, our Hold rating remains in place.

Following 4Q07 results and expected results and expected influences on 1Q08 results, we are lowering our 2008 and 2009 earnings expectations to $2.30 per share and $2.65 per share, respectively, from $2.65 per share and $2.85 per share, respectively. At the current price, the shares of STFC shares trade at 1.23x its 4Q07 book value of $23.10 per share. The company's share price-to-book multiple has been reduced by nearly two-thirds since its 3.1x high recorded after the company reported 3Q05 results. The current price-to-book multiple now hovers around the company's ten-year average, which is below its 1.6x historic level.

As expected, the company's ROE has peaked and should decline with the softening property-casualty cycle. In addition, the quantitative Zacks Rank for STFC is currently 3 (no change relative to January 16, 2008), indicating no clear directional pressure on the shares over the near term. Short interest ratio is currently 13.9 days, versus 14.8 days previously.

Therefore, we think the current price-to-book multiple is appropriate. Our new six-month target price of $29.65 per share, up from $27 per share, equates to a multiple of 1.25x (1.3x previously) to our estimated book value of $23.70 per share as of June 30, 2008.

Read the full analyst report on STFC.