We retain our Underperform recommendation on Progressive Corp. (PGR - Free Report) , following its second quarter earnings. Progressive’s earnings in the reported quarter lagged the Zacks Consensus Estimate as well as the year-ago results. The magnitude of the increase in expense was more than the increase in revenue, thus inducing lower numbers.
Combined ratio has been deteriorating over the past few quarters. It deteriorated 380 basis points over the prior-year quarter to 94.1% in the first quarter and 420 basis points to 96.7% in the second quarter. The combined ratio represents the percentage of premiums paid out as claims and expenses and is a primary measure of underwriting profitability. A higher combined ratio thus concerns the company’s profitability.
We expect underwriting margins to remain volatile considering the loss cost trends, the economic environment and the company’s growth initiatives. It declined to 5.9% in the first quarter of 2012 to 2.4% in the second quarter, attributable to higher loss costs due to an increase in severity and frequency. Also, it fell below the company’s long-term target of 4%.
Though Progressive has been experiencing improved results at its Commercial Auto businesses, maintaining the trend could be challenging. We expect sluggish economic recovery, increased competition and depressed levels of employment to be the headwinds.
Nevertheless, new businesses, higher premium per policy and customer retention aided the company to report better results over time. Also, Progressive undertakes share buybacks besides paying annual dividends to return more value to its shareholders. Given its favorable financial strength, we expect more shares to be repurchased going forward.
The quantitative Zacks #5 Rank (short-term Strong Sell rating) for Progressive indicates downward pressure on the shares over the near term. The Allstate Corporation (ALL - Free Report) , which closely competes with Progressive, holds a Zacks #2 Rank (short-term Buy rating), indicating slight upward boost on the shares in the near term.