Amerisafe Upped to Neutral

We have upgraded our recommendation on Amerisafe Inc. (AMSF - Analyst Report) to Neutral from Underperform based on its momentous performance in the third quarter of 2011, imbibing optimism for future growth.

The company’s third quarter operating earnings per share of 33 cents came in higher than the Zacks Consensus Estimate of 29 cents and 26 cents reported in the prior-year quarter. Operating income spiked 25.6% year over year to $6.2 million. Amerisafe’s total revenue for the quarter was $71.7 million, up 18.5% from $60.5 million in the prior-year quarter, also exceeding the Zacks Consensus Estimate of $66.0 million.

Amerisafe has a history of profitable underwriting in its industry. The policy renewal rates of the company on voluntary business consistently improved to 92.7% in 2010 from 91.8% in 2009, 91.7% in 2008 and 90.8% in 2007. We believe that the company’s specialized knowledge and extensive experience of insuring employers engaged in hazardous industries will help it serve policyholders better, leading to enhanced employer loyalty and policy retention.

After a period of downward growth in the past years, Amerisafe’s top line has started witnessing improvement in 2011 with an annualized growth of 11.2% in the first nine months of 2011. While higher premiums are driving growth, Amerisafe is able to generate more investment income.

Despite the lingering macro concerns, Amerisafe holds a risk-free balance sheet, which is reflected in its improved book value per share. This also enables Amerisafe to efficiently deploy capital, primarily through share repurchases, thereby retaining investors confidence, going forward. This is also evident from the expanded share repurchase program in October 2011.

On the flip side, lower investment yields followed by higher loss and loss adjusted expenses coupled with escalated underwriting and policy acquisition expenses have marred the desired upside in the operating income and margins so far in 2011.

Moreover, the workers compensation insurance industry is in the midst of a soft market cycle, characterized by increased competition that results in lower premium rates, expanded policy coverage terms and higher commissions paid to agencies.

Higher expenses, lower yields and soft macro factors have impacted the operating ratios such as combined ratios and return on equity. Given the current economic volatility, we do not expect much improvement in this sphere, in the near future.

Overall, given the pros and cons, the Zacks Consensus Estimate for the fourth quarter is pegged at 36 cents, a couple of pennies below the year-ago quarter. Over the last 30 days, 3 of the 5 firms have raised their estimates, while two downward revisions were witnessed.

For 2011, the earnings are expected to decline by about 20% over 2010 to $1.29 per share. Additionally, the quantitative Zacks Rank for Amerisafe is currently #3, indicating no clear directional pressure on the shares over the near term.

Read the full analyst report on AMSF