ACE Limited Retained at Neutral

ACE Limited ( ACE - Analyst Report ) remains well poised owing to its international presence, diversified product offering, risk management, conservative underwriting practice and strong reserves. Alongside, it is focused on enhancing its earnings, return on equity and book value per share.

Also, in its concerted effort to enhance shareholders value, the Board intends to propose a dividend hike. It also scores strongly with the rating agencies.

However, exposure to catastrophe losses and the continued low interest rate environment dwarfs the positives. Thus, we retain our Neutral recommendation.

After embarking on an acquisition spree in 2010 and 2011, the company continues to make strategic acquisitions. Recently, the company agreed to acquire PT Asuransi Jaya Proteksi in Indonesia for $130 million in cash, thereby aiding the company to diversify its business there.

Acquisitions have created a turnaround in premium writings and in turn have helped the company deliver better numbers, which is expected to continue, going forward. With considerable balance sheet strength, we expect ACE to grow both organically and inorganically.

The company expects premium growth to gain momentum in each quarter averaging in mid- to-upper single digits in 2012. It also estimates agriculture premium to be lower by $250 million from the year-ago level.

ACE is also focused on returning more value to its shareholders. The Board of Directors authorized a 4.25% increase in its quarterly dividend. The company has a record of increasing its dividend every year. Its dividend yield is 2.68%, which is above the industry yield of 2.08%.

In the first quarter of 2012, ACE bought back 0.1 million shares for $7 million. As of March 31, the company is left with share repurchases worth $461 million under its authorization. Given its strong capital and liquidity position, and capital exceeding $30 billion, we expect to see further buyback spending from the company, which will boost its bottom line.

ACE’s earnings generating capability and stability supported by its conservative reserving philosophy and commitment to underwrite profitability provide a solid base for its enterprise risk management program. As such, the company strongly scores with the credit rating agencies. A.M. Best reiterated the issuer credit ratings (“ICR”) and senior debt ratings of “a” of ACE Limited and ACE INA Holdings Inc.

Concurrently, the rating agency reiterated the financial strength ratings (“FSR”) of A+ (Superior) and ICR of “aa” of the North America property/casualty subsidiaries of ACE Limited, ACE Bermuda Insurance Ltd., ACE Tempest Reinsurance Ltd, the members of the ACE American Pool and ACE INA Insurance. The outlook remains stable.

Furthermore, A.M. Best revised the FSR to A+ (Superior) from A (Excellent) and ICR to “aa” from “a+’’ of Penn Millers Insurance Company with a stable outlook. We believe, the company’s strong ratings scores will help retain investor confidence and help it write more business going forward.

Nevertheless, ACE has substantial exposure to losses resulting from natural disasters, man-made catastrophes and other catastrophic events. Though the entire industry benefited from lower cat loss in the first quarter, exposure to cat activities will always remain a concern as natural disasters can affect the results adversely. The company’s operating earnings include an estimated cat loss of $325 million for the remainder of 2012.

Low interest rate environment continues to weigh on net investment income and the recent quarter was no exception. Lower yields on new investments coupled with lower private equity fund distributions offset positive operating cash flows and a higher overall average invested asset base from acquisitions, thereby resulting in no momentum in investment income in the quarter.

The quantitative Zacks #3 Rank (short-term Hold rating) for the company indicates no clear directional pressure on the shares over the near term. The company competes with American International Group Inc. ( AIG - Analyst Report ) and The Travelers Companies Inc. ( TRV - Analyst Report ) .