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Alleghany Down 36% YTD: High Cost to Hurt the Stock Further?

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Alleghany Corporation (Y - Free Report) continues to be adversely impacted by escalating costs and weak underwriting results, which, in turn, are straining margins.

Shares of this Zacks Rank #4 (Sell) property and casualty (P&C) insurer have lost 36% on a year-to-date basis compared with the industry’s 18.8% decline.

The company has an unimpressive surprise history. It has a trailing four-quarter negative earnings surprise of 40.6%, on average. The Zacks Consensus Estimate for earnings for the current quarter has been revised 55.1% downward over the past 30 days.

Factors Affecting Alleghany

The P&C insurer continues to suffer from increased costs, primarily owing to higher losses and loss adjustment expenses, operating expense and commissions, brokerage and other underwriting expenses. Such costs tend to put pressure on the company’s margin expansion. In first-quarter 2020, net margin contracted 880 basis points (bps) sequentially and 330 bps year over year.

Being a P&C insurer, Alleghany remains exposed to catastrophe losses, which in turn impact underwriting results. Catastrophe loss soared 5241.2% year over year in first-quarter 2020. The company’s underwriting results were primarily dented by COVID-19-induced financial turmoil, which in turn resulted in deterioration in the combined ratio in the first quarter.

Net investment income — an important driver of the P&C insurer’s top-line growth — declined in first-quarter 2020, mainly due to losses incurred on credit-related partnership investments. Also, the prevailing low interest rate environment is likely to keep investment yields under pressure. Moreover, equity market fluctuations weigh on the company’s overall investment income.

Furthermore, Alleghany’s debt levels have been increasing over the past four years. Nevertheless, the company’s long-term debt declined in first-quarter 2020. However, as of Mar 31, 2020, its long term debt to capital of 18% was higher than the industry’s 1.3%. The P&C insurer’s interest coverage ratio of 1.84 compares unfavorably with the industry’s 4.31, which implies that its earnings are not sufficient to cover interest obligations.

Additionally, Alleghany’s trailing 12-month return on equity of 3.3% is lower than the industry’s 6.5%. This highlights the company’s inability to utilize shareholders’ funds.

We believe that such potential headwinds are likely to dent its growth prospects going forward.

Stocks to Consider

Some better-ranked stocks in the insurance space include American Equity Investment Life Holding Company (AEL - Free Report) , EverQuote, Inc. (EVER - Free Report) and Palomar Holdings, Inc. (PLMR - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

American Equity Investment is a full-service underwriter of a broad line of annuity and insurance products, with primary emphasis on the sale of fixed rate and index annuities. It beat estimates in each of the trailing four quarters, with the average surprise being 63.04%.

EverQuote provides online marketplace for insurance shopping, primarily in the United States. It beat estimates in each of the trailing four quarters, with the average positive surprise being 86.7%.

Palomar provides specialty property insurance products for individuals and businesses. It has a trailing four-quarter positive earnings surprise of 10.9%, on average.

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