We are maintaining our Underperform rating on Cincinnati Financial Corp. (CINF), as we believe that a weak economy, low investment yield and bad weather will weaken its return on equity.
Cincinnati Financial recently predicted cat losses of $88-98 million after suffering a weather-related loss of $290 million in the second quarter, which led to an operating loss of 57 cents per share.
Top-line growth at Cincinnati Financial has been sluggish for the past several years due to weak markets and economic pressures. The lingering effects of soft insurance market pricing are expected to impact growth rates and earned premium levels in 2011 and possibly beyond, depending on insurance market conditions. These conditions continue to weaken loss ratios and hamper near-term profitability.
Commercial Lines, which accounted for 73% of 2010 net written premiums, is still experiencing very strong competition in the market, along with a pricing decline in the low single digits and reduced insured exposure levels that include negative effects on audit premium.
However, net written premiums were down 26 million or 1% in 2010, which is a smart improvement from the 6% decline in 2009. We expect the segment to remain somewhat weak until the fragile economy strengthens significantly.
Cincinnati Financial has also experienced investment portfolio problems as a result of equity investments, which form a significant portion of its portfolio. Though the portfolio has been diversified to reduce equity concentration (26.4% of the total portfolio as of December 31, 2010), it continues to have an equity-bias relative to its peers, exposing the company to equity market related volatility. Moreover, low yield for investment options is expected to continue, thereby limiting investment income growth.
Cincinnati’s Personal Line segment, which consists of Personal auto, homeowners and other lines, had also underperformed from 2006 to 2009. However, with an improvement in new business levels, strong retention levels, as well as rate increases that affected the homeowner line in 2009, the segment has recently been witnessing premium growth.
Though management is looking to diversify property risks by writing more business in newer states (that carry lower inherent cat risk), we think this effort will take time before any noticeable benefit shows up in margins. Meanwhile, underwriting could be subject to volatility if storm activity remains at historically high levels.
Cincinnati’s Life Insurance segment is also showing favorable performance and remains an important contributor to operating results, helping to smooth out the variable results from the company’s property and casualty operations.
The company’s Excess and Surplus lines are also performing well. Despite a soft market environment, the segment has been able to achieve rate increases for nine consecutive months.
Despite the operating headwinds, Cincinnati Financial has been able to keep its long-standing dividend increase streak intact this year (50 years and counting), thus retaining its attractiveness to investors. But given the weakness surrounding the company’s business, we believe that dividend alone will not be sufficient to encourage investors to remain invested over the long term.
Considering Cincinnati’s uncertain operating environment, we are currently maintaining an Underperform recommendation. We may revisit our recommendation if the third quarter earnings release scheduled on October 28, 2011, throws more positive light on the company’s operating environment.
Cincinnati’s close peers The Chubb Corp. (CB), The Travelers Companies Inc. (TRV), and Selective Insurance Group Inc. (SIGI) will also report earnings in the imminent future. All of them are expected to suffer from weather-related losses.
CHUBB CORP (CB): Free Stock Analysis Report
CINCINNATI FINL (CINF): Free Stock Analysis Report
SELECT INS GRP (SIGI): Free Stock Analysis Report
TRAVELERS COS (TRV): Free Stock Analysis Report
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