We are reiterating our Neutral recommendation on the shares of Delphi Group Inc. (DFG).
Delphi Financial Group’s first quarter 2011 core operating income of $0.91 per share was in line with the Zacks Consensus Estimate. The company’s insurance businesses achieved a strong top-line growth during the quarter as it benefited from improving payroll trends in its small case market niche at Reliance Standard and continued market share gains for Safety National’s products. Both the wings of Dephi witnessed a significant price hike, which was hailed to be the largest in the past several years.
Safety National has been expanding its leading market share in providing coverage to self-insureds, with its market share increasing to 25% in 2010 from 22% in 2008. It has increased premiums at a CAGR of 6% from 2006 to 2010. Management expects an attractive market for the Excess Workers’ Compensation following the positive trends in January 2011 renewals, with average rates up 2% and increased average self-insured retention. (Safety typically writes 25% to 30% of its business in January and the pricing on these renewals generally set the tone for the year). An average of 1% increase in payrolls, along with increases in healthcare, schools, and public entities balancing declines in other areas, provides room for further business growth. High levels of production and good renewal experience further point towards an increase in business. Moreover, the long-tail nature of this business, with an average duration of 15+ years, reflects a large investable float. But, along with it, comes a long-tail risk related to the uncertainty of the claim payments. However, given the company’s use of reinsurance and the increase in self-insured retentions, we believe that the company can effectively manage the long-tail claims exposure that provides it with free cash to invest for long term.
At Delphi’s life insurance unit Reliance Standard, core premiums in first quarter 2011 was up 5% compared with 1% increase recorded last quarter. Core production surged 40% as against 9% in the previous quarter, as the unit benefited from a strong position in the small case market and its differentiated offering for larger cases with its integrated employee benefit program. The unit is expected to benefit from its niche focus on the small case segment (companies with less than 500 employees), which reportedly witnessed 400,000 jobs addition in December and January, accounting for almost 90% of total job growth within this time period. Moreover, at Reliance Standard, voluntary products continue to be a major growth driver as employers seek to control costs (voluntary premiums were up 9% in the quarter). Thus, after 1.6% and 1.1% decline in core premiums in 2010 and 2009, respectively, the unit witnessed a marked improvement in business during the first quarter of the year. Though we expect business growth, it will be somewhat offset by competitive pressures on group employee benefits and the uncertain employment scenario. Besides, high long-term disability claims incidence will also be a headwind.
Additionally, Delphi has been consistently returning value to its shareholders through dividend payments and share repurchases. It has been increasing dividend every year since its initiation of dividend payment in 2001. In May 2011, the company announced a 9% hike in its quarterly dividend. The dividend growth rate averaged 16.7% over the past five years, reflecting a solid balance sheet. It has also improved its balance sheet by reducing the debt-to-capital ratio to18% at 2010 end from 19% at 2009 end and 26% at 2008 end. However, management did not seem much enthusiastic about share buyback during the fourth quarter conference call, although it contemplated strategic acquisitions or deploying money for investment.
Delphi is also poised to benefit from strong ratings conferred on it and its subsidiaries by all the major rating agencies. Its subsidiaries, Reliance Standard and Safety National,carry financial strength ratings of "A”, “A-”, “A3” and “A” by A.M. Best, Fitch, Moody’s, and Standard & Poor’s, respectively.
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