Hartford Falls to Underperform

Last week, we downgraded our recommendation on Hartford Financial Services Group Inc. ( HIG - Analyst Report ) to Underperform based on its weak third quarter results.

The company reported third-quarter 2011 operating earnings per share of 93 cents, comfortably beating the Zacks Consensus Estimate of 23 cents. However, earnings were behind 98 cents reported in the third quarter of 2010.

Hartford’s financials and operations are significantly impacted by the challenging regulatory environment and fluctuations in the fixed income or equity markets. In fact, low interest rates since the mid-2010 coupled with the slow recovery of the economy have prompted management to declare that the achievement of the previously announced ROE target of 11% will be delayed beyond 2012-end, as planned earlier.

Net investment income of Hartford also varies significantly with changes in market conditions. While the company’s net investment income improved substantially in 2009 from 2008, it declined in 2010 and the first nine months of 2011. With the ongoing weak market conditions and the possibility of a double-dip recession, the poor investment results are expected to continue beyond 2011.

Further, the statutory surplus of Hartford at the end of September 2011 declined to $14.8 billion from $15.5 billion at 2010-end. Additionally, management expects the statutory surplus in Life operations to continue declining in the fourth quarter of 2011 and through 2012 due to expenses related to increased hedging activities, spread compression and decline in Group Benefits earnings.

On the other hand, Hartford’s capital raise, repayment of government funds and measures to de-risk its balance sheet, have increased confidence in its capital strength. Further, the investment portfolio has strengthened due to improved investment methods and active risk management undertaken by the company.

Additionally, Hartford recently implemented a hedge program for its Japanese operations, which forms one of the largest components of Hartford’s international business and has been under considerable competitive pressure from both domestic and foreign insurers. The hedge program is expected to reduce the risk and ease the pressure on the company’s deposits in the Japanese market.

Moreover, in order to concentrate on its U.S. operations and enhance its operating leverage, Hartford has been selling off its non-core businesses one by one. Recently, in October 2011, Hartford sold its subsidiary Trumbull Services LLC to ExlService Holdings, Inc. ( EXLS - Snapshot Report ) . Such divestitures will enable the company to focus all of its manpower and financial resources on its core businesses, thereby improving the operating performance.

Considering the pros and cons, the Zacks Consensus Estimate for Hartford’s fourth-quarter 2011 earnings is currently 85 cents per share, down about 20% year over year. For 2011, the Zacks Consensus Estimate stands at $2.17 per share, down about 35% over 2010. Currently, Hartford carries a Zacks #5 Rank, implying a short term Strong Sell rating.

On Friday, the shares of the company closed at $17.27, up 0.35%, on the New York Stock Exchange.