Hilltop Upped to Outperform

We have upgraded our recommendation on Hilltop Holdings Inc. (HTH - Analyst Report) to Outperform from Neutral based on its sound capital position along with a risk-free balance sheet, which also paved the way for resumption of share buybacks, imbibing shareholders' confidence in the stock.

Hilltop broke even in the third quarter of 2011 against the loss of 13 cents in the year-ago quarter and the Zacks Consensus Estimate of loss of 22 cents per share. Net income also rose to $0.25 million from a loss of $7.2 million in the prior-year quarter.

Results benefited from modest underwriting profitability, premiums growth, net realized gains and investment income that drove the top line. However, this growth was offset by higher-than-expected expenses, which in turn hampered the combined ratio and resulted in operating cash outflow.

Post restructuring, NLASCO remains the key driver for Hilltop's revenues. Besides, the company’s firm grip on the local personal property insurance market adds value to the overall Hilltop business in its operating areas. Improvement in premiums written in 2010 over 2009, coupled with other factors, has not only supported Hilltop’s top-line growth but also helped contract its operating losses from 2008 through 2010.

Despite the challenging operating environment, Hilltop’s balance sheet remained risk-free and fairly liquid. Moreover, Hilltop’s investment, debt and securities along with its subsidiaries are well poised in the market owing to their superior financial strength and credit ratings. This leaves excess capital and ample scope for more meaningful acquisitions and alliances for the company’s long-term growth.

Moreover, Hilltop’s healthy capital deployment strategy is also reflected from the new $100 million share repurchase program announced in November 2011. While the repurchases will be initiated through open market operations, depending on the market conditions, the program is scheduled to expire on November 1, 2012. The share repurchase program also bodes well for retaining confidence in the shareholders.

However, Hilltop’s vast exposure to the weather-risk prone areas increases the loss and loss adjustment expenses, which also affects claim ratios, combined ratio and underwriting expense ratios. Additionally, Hilltop’s sole dependence on inorganic growth (from the NLASCO acquisition) in an intensely competitive insurance industry and volatile economy continues to be the cause of concern in the intermediate term.

Overall, Hilltop’s future performance will largely depend on the prudent deployment of its reserves. We thus expect the company to grow and evolve in the upcoming quarters by expanding its operations, which should further drive the desired upside in the stock.

Weighing the pros and cons, the Zacks Consensus Estimate of earnings for fourth-quarter 2011 is currently pegged at 2 cents, in line with the year-ago quarter. However, for 2011, loss is estimated to be 19 cents, down from 24 cents in 2010.

Additionally, the quantitative Zacks Rank for Hilltop is currently #3, translating into a short-term Hold rating, while our long-term stance remains Outperform.

Read the full analyst report on HTH