Investment Thesis
American Coastal Insurance (NASDAQ:ACIC) has given investors a very strong first quarter earnings, with an underlying combined ratio of 57.8% and core ROE of 69.7%. These outstanding profitability metrics are quite unbelievable to me and set this insurance company apart from its peers, yet its valuation metrics are very cheap in relation to the sector median. Therefore, I expect profitability to continue to be strong as coastal homeowners insurance continues to offer attractive premiums for investors. Shares are a buy as they present compelling profits at a cheap price, in my view.
Company Overview
American Coastal Insurance according to the annual report is “primarily engaged in commercial and personal property and casualty insurance business with investments in the United States”. They focus on writing property and casualty insurance in Florida and New York, two of the most risky states to underwrite policies, in my opinion.
They seem to have a contrarian-like underwriting strategy where they specifically go after risks that are perceived to be higher than they actually are. According to the annual report,
Our target market in such areas consists of states where the perceived threat of natural catastrophe has caused large national insurance carriers to reduce their concentration of policies. We believe an opportunity exists for ACIC to write profitable business in such areas.
To me, this unusual underwriting strategy is working quite effectively, with very high profitability metrics in the first quarter showing how in underwriting there are no bad risks, only bad premiums. Management also utilizes reinsurance to protect their downside,
AmCoastal’s core catastrophe reinsurance program provides occurrence-based coverage up to an exhaustion point of approximately $1,100,000,000 for a first occurrence and $1,300,000,000 in the aggregate.
I am surprised by the carefulness and coverage American Coastal receives on their reinsurance policies. The relationship and reputation American Coastal has with its reinsurance partners seems to be very strong as they continue to get good coverage with pretty high limits. American Coastal’s reputation for extremely profitable underwriting seems to get them pretty favorable reinsurance policies, which then fuels this positive feedback loop by continuing to strengthen their reputation.
In addition, American Coastal seems to be a highly efficient low-cost operator in the P&C insurance space. Their overall expense ratio for Q1 2024 improved from 43.4% to 35.2% YoY, which is impressive to me because going from efficient to super-efficient can be quite difficult. Their investment strategy is also pretty textbook for an insurance company, focusing mostly on stable debt securities with satisfactory return.
All in all, American Coastal Insurance stood out as being an immensely profitable insurance company that has a contrarian-like underwriting philosophy with a low-cost operational history. In this market, I feel that the high-perceived risks in the P&C space now have premiums that adequately reward the underwriter for taking on this risk.
As I said before, I feel that American Coastal fully understands that there are no bad risks, only bad premiums. With solid reinsurance support, I feel American Coastal Insurance is set to outperform its peers in the P&C space, which justifies my bullish view on the company. After a brutal 2022, this company looks set to redeem itself and set new highs for shareholders in my opinion.
Earnings Seem Well-Protected
The company reported first quarter earnings with the following results:
- Net income attributable to the Company for the first quarter ended March 31, 2024, was $23.6 million, or $0.48 per diluted share
- The Company’s total gross written premium increased by $10.3 million, or 5.5%, to $197.5 million for the three months ended March 31, 2024
- Loss and LAE decreased by $0.5 million, or 3.1%, to $15.9 million for the three months ended March 31, 2024
American Coastal attributes this strong performance to better rates in high-perceived risk areas like Florida, in both the commercial and personal lines businesses. Furthermore, the company has been very careful to cut costs by lowering policy acquisition costs “primarily due to an increase in ceding commission income due to changes in the terms of the Company’s quota share reinsurance agreements effective June 1, 2023” according to the press release.
I think earnings seem well-protected now due to very strong reinsurance agreements alongside properly priced insurance policies in the commercial property line in Florida. Furthermore, the company recently renewed its MGA agreement with AmRisc, entering a five-year extension of the agreement until 2029.
Despite being in Florida, I think this company has that region on lockdown. Their expertise, experience, and incredibly low-cost operations should enable them to survive in that arena profitably. While everyone else has left (or gone bankrupt), it seems that American Coastal has the pricing power to negotiate more favorable policies for shareholders.
In conclusion, this first quarter earnings report leads me to believe the company is on the right track again. Investors had left the company for dead in November of 2022, but the market has correctly recognized the subsequent recovery. I believe there is more room for the stock to run up, as management expects continued momentum in premium growth, according to the transcript,
Furthermore, we expect net written and earned premiums to increase substantially over the next 18 months accelerated by our planned reduction of external quota share at June 1, 2024.
With ROEs at very high levels, American Coastal Insurance seems like a good buy for the next 18 months, as it is likely their premiums will increase enough to keep earnings steady. Therefore, I remain bullish and expect the stock to reward investors as shares follow these impressive profits.
Personal Lines Approach Profitability
The first quarter earnings revealed that the loss ratios for the personal lines insurance spiked from 29% to 71.4% YoY. In response to this spike in loss ratio, management has been super focused on cutting costs and cut their expense ratio from 111.5% to 36.7% YoY in the first quarter earnings. Their personal lines insurance segment was super inefficient in 2023 and has now become very manageable.
Going forward, I expect the personal lines market to correct, meaning their loss ratios should normalize downwards towards a more typical ratio of around 50%. So, as the combined loss ratio improves for the Personal Lines segment, this growing positive momentum can add to earnings which should drive the stock price up. Management explains in the press release,
In addition, the Company saw an increase in written premiums across the personal lines business, due primarily to rate increases.
Rate increases seem stable across the board as Florida continues to see shortages of willing insurers ready to write property insurance policies. While some may be afraid of a coming explosive hurricane season, my belief is that management has well-prepared their underwriting portfolio for this obvious risk. Their reinsurance agreements have low retention of only $10,000,000, which to me adequately protects American Coastal from extreme losses.
I expect the personal lines combined loss ratio to break below 100% in the coming quarters, which should add to solid earnings growth for shareholders. This can be seen by some as a catalyst that may spark a rally in the share price, with book values growing consistently in the double-digits. All in all, investors can expect solid earnings from here on out in my opinion.
Valuation – $15 Fair Value
Assuming revenues grow at around the sector median of 5% according to Seeking Alpha, sales should reach $300 million by 2025. The company is on track to reach $300 million in sales this year as they have around $75 million in sales for the first quarter, and assuming this quarterly rate keeps up they could have close to $300 million in revenue for 2024.
Apply a net margin of 25% which is close to the sector median of 23% gets me earnings of $75 million. I believe 25% profit margin is conservative given the extremely high ROEs and low combined loss ratios this insurer can earn with a very contrarian underwriting strategy in Florida. Furthermore, the earnings are well-protected by a heavily armored reinsurance plan with several layers of protection.
Divide $75 million by shares outstanding of 48 million gets me an EPS of $1.50, rounded down. Apply a 10x P/E gets me $15 per share fair value. I believe a 10x P/E is fair because it is a little under the sector median of 11.8x, demonstrating my conservative valuation approach.
Some investors might pause at the seemingly high P/B ratio of 2.0x. However, I would argue that the P/B ratio highlights a weary past, as the company had reported ugly losses back in 2022, losing $10 per share. In other words, the P/B ratio is backwards looking and potentially distorts the brighter future American Coastal may achieve. Therefore, the P/B ratio may not give investors an accurate picture of the future valuation, and I recommend investors underweight the P/B ratio of this insurer.
Risks
P&C Insurance is always a volatile business in my opinion, and so investors may get hit with hurricane season, which could put the balance sheet at risk. Although the reinsurance plan has several layers and a CAT bond, Mother Nature could potentially break through and cause investors another situation that rhymes with FY2022. Growing climate change continues to amp up the frequency and severity of named storms, which challenges many P&C insurers, especially in coastal regions.
I’m not sure if this company can get any more efficient, as the expense ratios are incredibly low already. We are potentially seeing combined loss ratios go as low as possible, making any further improvements very difficult. To go from bad to good can be easier than great to exceptional. So, one can wonder if there’s any more room left for further operational efficiency improvements.
Investment income could perform negatively if interest rates rise, causing the value of fixed-income securities to decline. Furthermore, the lack of diversification for American Coastal regionally puts them at risk of concentrated exposures to one-off events.
Buy American Coastal
From rock-bottom in November of 2022, this stock has had a marvelous comeback. They rebranded, refocused, and shifted successfully to focusing on a contrarian-like, careful underwriting strategy in my view. The P/B ratio is backwards looking, which can throw off investors as it includes an ugly past, making it look optically overvalued. However, I believe the forward earnings growth undervalues this reformed insurer, and thus I rate shares as a buy.
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