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Allstate's storm-damaged stock is a buy
The insurance giant made sure to reduce its liabilities along the Gulf Coast before Katrina hit, so patient investors will see its share price bounce back from post-hurricane losses.
By Robert Walberg
Like the ad says, you are in good hands with Allstate. Unless your house was flooded by Hurricane Katrina. Or if you happen to live along hurricane-prone stretches of the East Coast.
If either is the case, your fate may be in your own hands. Allstate's homeowners insurance policies, like most insurers', don't cover flood damage. And the company has drastically cut back or flat-out stopped writing policies in areas hit hard by storms in recent years. In coastal areas where it has stayed, Allstate has in many cases raised its premiums considerably to cover the added risk.
So, yes, Allstate (ALL, news, msgs) stands to pay billions of dollars in claims from the most costly hurricane in history. But it could have been worse. For investors willing to wait, that means there's profit to be had.
So far, estimates for insured losses from Katrina range from $10 billion all the way up to $60 billion. Even if you took the average of those estimates, $35 billion, that would easily eclipse the record $15 billion ($21 billion in today's dollars) paid by insurers after Hurricane Andrew.
One thing that will make the ultimate loss number hard to nail down is a growing dispute between insurers and policyholders over what is considered flood damage. The insurers say flood damage of any type is not covered by their policies, and that they haven't collected premiums to cover such damage. Policyholders quoted in recent news stories contend that their homes were destroyed by a combination of wind and water, which would require at least partial payment from the insurers.
Andrew crushed the insurance industry and bankrupted about a dozen companies. Katrina is likely to have a more muted impact, in part because the insurers have become better at avoiding some high-risk areas. Another big reason for this is the continued emergence of small reinsurers -- including Montpelier Re (MRH, news, msgs), United Fire & Casualty (UFCS, news, msgs) and RenaissanceRe Holdings (RNR, news, msgs) -- willing to take on some of the catastrophic risks faced by primary insurers.
Passing the storm-loss buck
Basically, reinsurers insure the insurance companies against big losses. Of course, if the reinsurers were to fail due to an abnormally large number of claims, then the liability reverts back to the primary insurance company. This is one reason it's still too early to get a good handle on the end risk to companies like Allstate. However, it should be noted that the reinsurance industry, like the insurance companies themselves, has gotten wiser since Andrew.
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More and more reinsurers now spread their own risks by purchasing something called retrocessional reinsurance. That's a fancy way of saying reinsurance for the reinsurance companies. If early estimates are even close to correct, retrocessionaires, such as PXRE Group (PXT, news, msgs), are apt to get clobbered. Other reinsurers, too, are at risk from retrocessional policies, which they often write for one another. Failures at any point down the line send the losses back up the food chain. It's the insurance industry's version of the domino theory.
Nevertheless, the use of reinsurance should be a buffer for many insurers against Katrina losses. Allstate insures about one in five homes in Louisiana and Mississippi, but won't pick up anywhere near 20% of the storm's losses. Wall Street is estimating that the liability will be somewhere in the area of $1 billion to $1.75 billion after taxes. Granted, that's a lot of coin, but for a company that has $3.8 billion in cash, has billions more set aside to pay claims and generates more than $3 billion in free cash flow, it's manageable.
Taking the long-term view
Even after Katrina, analysts expect Allstate to earn about $4.30 per share in fiscal year 2005 and close to $6.50 per share in 2006. It's early, and once the company and Wall Street get a better feel for the extent of the damage, those numbers could move up or down. To be safe, let's assume that they are overstated by 10% and reduce the projections to $3.87 and $5.85. Based on these relatively conservative estimates, Allstate currently trades at 13.9 times estimated earnings for this year and 9.2 times the next, respectively. The median of its historical range is 11 times.
In other words, the stock's 7.8% post-Katrina drop has left the stock trading at, or modestly below, fair value. Though additional downside risk is possible over the short-term as claims estimates fluctuate, additional losses should be minimal.
For those investors willing to accept some short-term risk, getting your hands on some Allstate stock is a good idea. Not only will the company be one of Katrina's survivors, but it is likely to benefit from Allstate's own risk aversion and higher premiums charged down the road. At today's discounted prices, the stock has long-term upside of 25% to 30%.
At the time of publication, Robert Walberg did not own or control shares of companies mentioned in this column.
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