Looking Beyond GAAP Consolidated Figures: This Loss Making Insurer is a Buy
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The GAAP accounting rule has been improved over the years to truly reflect business fundamentals. However, it should be treated with care by investors as even with so many improvements, it still has limitations. One particular case is when a holding company, with many subsidiaries, consolidates its financial figures. The more subsidiaries are lumped together, the less useful those presentations are for making informed investment decisions. Warren Buffett commented that Berkshire Hathaway (NYSE: BRK-A) prepared consolidated numbers only for outside requirements, but he and his lifetime partner, Charlie Munger constantly studied segment data.
That is the case with Old Republic International (NYSE: ORI), a holding insurance company. Old Republic has around 27 insurance subsidiaries in all 50 States and in Canada, operating in three main segments: General Insurance, Title Insurance and RFIG (Consumer Credit Indemnity (CCI) and Mortgage Guaranty (MI)). RFIG segment is in a run-off mode, meaning the company has stopped writing new policy for CCI and MI lines, it only settled the claims from the previous written policies. The other two segments, General Insurance and Title Insurance are running well and profitably. Because RFIG is generating a loss and it need to be consolidated into Old Republic's financial statements, RFIG drags the consolidated financial earnings into losses.
Yesterday, Old Republic reported its quarterly earnings result. Fortunately, the loss for the third quarter has been narrowed down as the company paid out fewer claims in mortgage insurance subsidiaries. The third quarter loss was $14.8 million, nearly only 1/10 of the same quarter's loss last year of $116.5 million. RFIG’s operating loss in the third quarter has been reduced by nearly 50%, from a $250 million loss last year to nearly a $133 million loss this year, whereas the General Insurance and Title Insurance segment had pretax operating income of $60.3 million and $21.7 million, respectively.
It is a good sign to see the RFIG segment narrowing its loss gradually. But even if RFIG was in the worse situation, I personally do not think it would affect the holding company as long as it does not commit any further capital to RFIG. ORI’s chairman and CEO Aldo Zucaro commented on a conference call that the company viewed RFIG run-off business as being akin to a discontinued operation. And the company would keep including RFIG operations in the consolidated financial statements.
“We say akin too because existing GAAP accounting rules do not allow financial reporting treatment as in fact a discontinued operation even though that is effectively what’s happening with it, since it’s being driven as I say, for an extended run-off period…So in the mean time, we will just plug along, and we’ll include, we’ll keep including the RFIG results in the Old Republic consolidated statements in the same manner as we’ve shown in this morning’s report as well as in the second quarter report when we reconfigured the financial presentation of our business. As we’ve indicated in the past, we are very confident that RFIG will continue to register losses well into 2013 with still a good chance that the red ink should begin to disappear sometime in 2014.”
In addition, ORI has continously paid increasing dividends for 44 years. With the current share price of $10.12, the dividend yield is as high as 7%. Among its peers including Radian Group (NYSE: RDN) and Fidelity National Financial (NYSE: FNF), ORI offers investors the juiciest dividends. Radian Group has a dividend yield of only 0.22% and Fidelity is paying investors a 2.48% yield. In terms of valuation, ORI is currently trading at 0.7x P/B, comparable to what Radian is trading right now. FNF is much more expensive with 1.3x book value. It is quite understandable that the market values Fidelity highly as Fidelity is the industry leader with 45%-50% market share in the title insurance market. And for Radian Group, it is the credit enhancement company with the main operation in first lien residential mortgage insurance and financial guaranty. The mortgage insurance industry has suffered from billion dollar losses because policies had been sold too cheaply before the housing bubble went burst. As being a player focusing on mortgage insurance, Radian Group is not an exception.
My Foolish Take
I wrote an analysis about ORI when the share price was $9.45 in the middle of September, so the share price has advanced 7% in more than a month. And I am still bullish on this stock at the moment because of the following reasons:
- Consolidated financial statements are overstating the risks of RFIG, although I think the negative income from RFIG subsidiaries would not drain the holding company.
- Juicy dividends of 7%, and there is a high probability that ORI will sustain the dividend because the holding company can benefit from profitable subsidiaries in General Insurance and Title Insurance segments.
- It is trading at a 30% discount to the book value.
- The investment portfolio of $8.4 billion is worth much more than the current market capitalization of $2.6 billion.
- The chairman and CEO bought more than $160,000 worth in shares in July and August this year. And he is the largest non-institutional investor in the company, with more than 1.2 million shares.
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hoangquocanh has a long position in Old Republic International. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
