Friday, July 24, 2015

ACE Limited (ACE) Dividend Stock Analysis

ACE Limited (ACE), through its subsidiaries, provides a range of property and casualty insurance and reinsurance products worldwide. It operates through five segments: North American P&C, North American Agriculture, Insurance, Overseas General, Global Reinsurance and Life Insurance. ACE Limited is a dividend achiever, which has raised dividends for 23 years in a row.

The most recent dividend increase was in May 2015, when the Board of Directors approved a 3.10% increase in the quarterly dividend to 67 cents/share. After reviewing the past history of dividend increases however, I wouldn’t be surprised if there isn’t another dividend increase this year.

The company’s largest competitors include American International Group (AIG), Travelers (TRV), and Berkshire Hathaway (BRK.B)


Over the past decade this dividend growth stock has delivered an annualized total return of 10.80% to its shareholders.

The company has managed to deliver an 8.10% average increase in annual EPS over the past decade. ACE Limited is expected to earn $9.18 per share in 2015 and $9.50 per share in 2016. In comparison, the company earned $8.42/share in 2014. Earnings per share for property & casualty insurers tend to be lumpy, driven by the cyclical nature of insurance premiums. As a rule, these premiums are highest after major catastrophic events have occurred, and lowest right before the next catastrophe happens.

The Property & Casualty insurance business is very competitive, and is subject to price competition for a commodity product. Companies have the incentive to keep writing policies, even if premiums might not justify taking those policies, in order to keep market share. It takes a certain type of management skill to be able to only write policies at advantageous terms for companies, rather than mindlessly change growth.

One way to evaluate P&C insurance companies is through the combined ratio, which is a measure of insurance companies performance. The combined ratio is calculated by taking the sum of incurred losses and expenses and then dividing them by earned premium. A combined ratio below 100 shows that the company collected more than what it cost it to pay out.

The thing that every insurance company in the world is after is investment float. Float represents insurance premiums collected, that are not paid out yet. The insurance company gets to invest and earn a return on that sum. The insurance company has to be very conservative in how it invests that money, because usually it ends up paying out in claims as much as it collected in premiums. Only good managers tend to earn an underwriting profit, by consistently paying out less in claims than what they received in premiums.

I stumbled upon ACE, after waking up to the news that the company is acquiring Chubb (CB). After reviewing the information from Ace, I believe that I am going to exchange my shares in Chubb for ACE. In addition, I will also exchange any cash I receive for more shares of ACE.

A bet on ACE is a bet on the company’s CEO, Evan Greenberg. He is the son of Hank Greenberg, the legendary CEO of AIG. He has insurance running through his veins, and seems to have a good handle on things based on his past track record. I like the fact that he grows through acquisitions of good assets such as Chubb (CB). He doesn’t seem to be overpaying for the business, which should be accretive to shareholders. In addition, I like the fact that a large part of the acquisition will be paid in cash, which reduces dilution for existing ACE holders. As a holder of Chubb, I am not that happy with the cash, but at least I get to earn a good return in a short period of time.

As an added bonus, rising interest rates are good for insurance companies like ACE. This is because the rising interest rates will mean higher returns on fixed income investments they make in the future.

The annual dividend payment has increased by 14.60% per year over the past decade, which is higher than the growth in EPS. I would not bet on future dividend growth exceeding 8%/year.

A 14% growth in distributions translates into the dividend payment doubling almost every five years on average. If we check the dividend history, going as far back as 1995, we could see that ACE has indeed managed to double dividends every five years on average.

In the past decade, the dividend payout ratio has largely remained between 13.80% and 30.80%. The current payout ratio is high at 38.10%, but on a forward basis it is much lower. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Return on equity has been dropping over time, from a high of 17.60% in 2006 to 9.80% in 2014. I generally like seeing a high return on equity, which is also relatively stable or rising over time.

Currently, I find the company to be attractively valued at 11.30 times forward earnings and an yield of 2.60%. I am actually considering initiating a position in the stock, subject to availability of funds.

Full Disclosure: Long CB



Relevant Articles:

Dividend Companies I am Considering this Month
39 Dividend Champions for Further Research
Four Dividend Stocks for the Long Run
Six Quality Dividend Companies For Long Term Investors
Chubb Corporation (CB) Dividend Stock Analysis

13 comments:

  1. DGI,

    I have CB in a Roth account, I plan on holding through the transaction. I see that ACE is based in Switzerland, for those tax reasons I will probably off load ACE within the first or second year of having their stock. If this was my taxable account I would certainly hold on to them. Do you see that as the best move in a tax preferred account?

    - Gremlin

    ReplyDelete
    Replies
    1. Hi Dividend Gremlin,

      Due to Swiss withholding taxes, it might make sense to own foreign stocks in a taxable account.

      Best Regards,

      Dividend Growth Investor

      Delete
  2. It seems like a ton of insurance companies are *always* "attractively valued" -- except in the bad years when they have unexpectedly high payout costs, and then suddenly P/Es skyrocket. For example, according to Value Line, here are the "Average Annual P/E ratios" for Travellers Insurance (TRV) between 1999 and 2013.

    (Data is year by year from 1999-2013.)

    9.4 / 9.1 / NA / 31.0 / 13.8 / 19.9 / 14.0 / 7.8 / 7.8 / 8.7 / 7.0 / 8.2 / 17.4 / 10.3 / 8.8 / 8.8

    Between 2000 and 2001, underwriting income went from +$0.23 per share to -$10.76 per share! (Thus the "NA" in P/E that year - earnings went extremely negative.) That figure of $-10.76 would be more than enough to wipe out all the expected gains for 2015.

    ACE is similar -- even more years with super low P/E ratios:

    13.5 / 12.5 / NA / 19.5 / 7.7 / 12.6 / 15.2 / 7.7 / 7.4 / 7.1 / 5.7 / 6.9 / 9.3 / 9.5 / 9.8 / 10.6

    In 2001, earnings at ACE were -$0.63 per share. Again, a pretty big negative number.

    I own AFL and have thought about TRV and a few other insurers like MHLD - and I will put ACE on my watch list thanks to you - but so far I'm not convinced.

    ReplyDelete
    Replies
    1. Well, that's the nature of insurance. However, they still managed to raise dividends, so if dividend growth is the strategy, I don't see a problem. It is certain as death and taxes that insurance businesses from time to time will experience heavy losses on their earnings when insurance claims rise after an event has happened.

      I like the insurance business from a dividend growth perspective, and I'm long ace :-)

      Delete
    2. Ha, a company loses money in one out of 15 years, and somehow this is the only thing to focus on? Your comment werewolf is an example of a serious lack of perspective.

      Delete
    3. Sorry I should have been clearer. The point is that the price is not necessarily "low" just because it's currently trading at a P/E of 11 or whatever. The P/E is always "low" -- and my guess is it's because traders take into account that the P/E in a good year is not representative of overall performance. The company has to live through the bad years too. Which means, among other things, that the dividend payout ratio stays quite low as a percentage of earnings.

      This doesn't make ACE a bad stock, at all. Just taking note of one factor that affects whether we should really think of it as being undervalued right now.

      Delete
    4. I see where drwerewolf is coming from. Due to the cyclicality of the nature of the insurance industry, i.e., underwrite at a profit for a successive # of years and collect float upfront in preparation for eventual claim years, there's no point even looking at the P/E. Probably better to look at price book. On this basis, at 1.22 x book, ACE isn't exactly cheap. Between Jan 2008 and Dec 2012, ACE traded on average, at close to 1x book. Between March 09 and Oct 11, it traded at between .78x book and .96x book.

      If 1x book is "normal", it's 22% overvalued, and the target valuation is around $78. But in market land, things never just settle at "normal", they overshoot, ala March 09 and Oct 11, almost 2.5 years where P/B averaged .87x.

      I also don't think it's wrong to focus on losing money 1 out of every 15 years, if this is symptomatic of the risk profile inherent in the insurance industry. If they happened to price policy premiums wrong and they kept selling under-priced policies for 14 years, and the 15th year, they get wiped out (think Lloyd's of London), where would equity holders be?

      I recall from reading various Buffet's letters, his discussing not writing policies if the pricing wasn't right.

      Food for thought.

      Delete
    5. The analysis already talked about the cyclical and lumpy nature of results. The comment of Drwerewolf took one item out of context ( valuation), and then ignored absolutely anything else that was said in the analysis. They are good comments that might be helpful to others in their learning ( which is why I posted them), but they leave me the impression that the author didn't read the article.

      I am afraid you may have done a similar thing Daniel - look at one data point in isolation from anything else. P/B is a good way to value insurers. But you cannot look at it in a vacuum. The situation in 2008 was different than the situation today. You look at opportunities available for you Today, accross all industries. If ACE is selling at P/B of 1.1 vs industry P/B of 1.1 this is actually rather cheap. If the acquisition of CB is going to increase book value for ACE and its earnings power, then this is something that adds "value" - value that doesn't seem to be showing (yet) on the numbers you are throwing out. You cannot just look at some numbers in isolation. - you need to think about the whole picture.

      As for failure, any company can get wiped out. Actually, investing in the stock market is very risky, since you can lose 100% of your investment. But the combined ratio on ACE suggests it has managed risks very well.

      Will it manage risks well in the future? Will the acquisition of CB work well? I think the answer is yes.

      Can ACE be available at lower prices? Absolutely.

      Delete
  3. Sorry that should have been 1999-2014, not 2013.

    ReplyDelete
  4. The big (and indeed medium) sized insurers are certainly very attractive. Over here in the UK we have a healthy set of insurers to choose from which is excellent. For long-term investors they are always tempting especially during years when high payouts are forced upon them by circumstances (which usually shake off short-term investors).

    I think you're right about the Chubb purchase. I have been watching it progress. They do seem to have got a very good deal. Should be good for its investors!

    ReplyDelete
    Replies
    1. P&C insurance is a very competitive business. And Insurance companies have different niches too. You are correct that results could be lumpy, which is good for patient long-term holders like us.

      Delete
  5. Hi DGI,

    I find your blog very informative. I'm a recent university graduate and since I now have a full time job where I'm making a substantial amount of cash, I'm interested in getting an idea for how many years it would take to crate a portfolio where the dividend income is enough to replace my employment income. When you anticipate to reach your cross-over point -- where you no longer invest but begin withdrawing dividends -- what will the total amount of money invested across all your accounts be equal to? I'm anticipating that around $200,000- $300,000 invested is likely the ballpark, but this depends on how much the dividends have grown since you started investing. Thanks

    ReplyDelete
    Replies
    1. Hi James,

      It all depends on a variety of factors.


      You might like this article: http://www.dividendgrowthinvestor.com/2014/02/how-to-retire-in-10-years-with-dividend.html

      Best Regards,

      Dividend Growth Investor

      Delete

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