Big Opportunities From This Reorganization
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Hartford Financial Services Group (NYSE: HIG) is an insurance and financial firm based in Connecticut. The company has faced significant challenges over the past five years, but is having some success in repositioning the firm and moving forward. Management refocused the firm on its property and casualty (P&C) insurance business and is eliminating businesses that do not fit this line. Hartford has sold off non-core assets and is improving its credit profile. Ideally, its profile will resemble competitors like Travelers (NYSE: TRV) and ACE Limited (NYSE: ACE). Despite these moves, Hartford has not yet fully escapade legacy businesses, like life insurance, and the higher risks and volatility associated.
In late 2011 and into 2012, Hartford was under pressure to make significant changes to its business from Paulson & Co who was its largest shareholder at the time. Management assessed its various segments and decided to sell off certain businesses and not to break the company into pieces. A breakup would have left the parts with high levels of debt, Life in particular. By selling off three of the pieces, Individual Life Retirement Plans and Woodburry Financial Services, the firm raised capital and was able to exit non-core businesses. In addition, management decided to runoff the US and Japanese annuity businesses. The changes allowed a $2.2 billion reduction in statutory capital due to a greater surplus and less risk in the business. The company, reborn as a P&C, will target 20% leverage similar to Travelers’ and ACE Limited’s levels.
Shares strong in 2012
The shares outperformed, up 38.1%, in 2012 even after adjusting for risk – current beta of 2.01 – compared to the S&P 500, up 13.5%. While Bank of America recently initiated coverage with a Buy rating, FBR recently downgraded the shares to market perform. Of concern are 2013 earnings impact from the sale and runoff of the businesses. It could be more material and lead to estimate reductions by the Street, usually a negative catalyst for the shares.
Investors may look through the impact on 2013, instead focusing on ongoing debt reduction, an improved business model and a lot of upside to the shares if management executes on their plan to be a P&C. Currently, price to book of Travelers and ACE are between 1.1x-1.15x versus Hartford’s multiple of 0.49x. Travelers and ACE are not going through the same transformation and so they appear to have less uncertainty. During the transformation, Hartford’s return on assets has been very low compared to competitors too. Its ROA is 0.37% vs over 2% for Travelers and ACE. American International Group (NYSE: AIG) is undergoing similar changes as Hartford and trades at a 0.66x book value. AIG, however, is showing decent returns and is up over 45% in the last year. AIG is certainly a special case through given the government involvement and recent exit.
Hartford Investment Group participated in TARP and like other entities that did, they issued warrants as a result of their participation. However, unlike others such as Bank of America (BAC), the shares trade above the strike price and generally move along with it. The chart below shows how they have traded in comparison to each other. There are some differences: anytime you value an option, time is a factor, so are expectations on interest rates etc. See Stock Chart for HIG
HIG is an interesting stock to follow as it undergoes its transformation. Management has unlocked value by repositioning the company, getting out of certain businesses via runoffs and sales. It will likely continue to reduce the risk level and pay back debt, which should translate to higher share prices. That said, the strong run over the past year in HIG could lead to a cooling off period. Expectations may be too great in the short-term resulting in actual falling short. This could create buying opportunities for those looking to get long the stock.
mthiessen has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!