Travelers stock (NYSE: TRV), the property and casualty (P&C) insurance giant, gained roughly 14% – increasing from about $140 at the beginning of 2021 to around $160 currently, inching ahead of the S&P500, which grew 12% over the same period. The benchmark S&P Insurance Select Industry Index has made strong gains since the start of 2021 and the rise in Travelers stock confirms the same trend.
There were two main factors behind this: First, the approval of the $1.9 trillion stimulus package. Second, fast-paced Covid-19 vaccination drive in the U.S – 50.5% of the U.S population has received at least one dose of vaccine. The above reasons support the prospects of a strong economic recovery, which will likely help both the earned premiums and the investment income.
But is this all there is to the story?
Not quite, despite the recent gains, Trefis estimates Travelers’ valuation to be around $162 per share – slightly above the current market price – based on a key opportunity and one risk factor.
The opportunity we see is an improved trajectory for Travelers’ revenues over the subsequent quarters. Travelers reported revenues of $32 billion in the full year 2020 – marginally above the year-ago figure. It could be attributed to lower growth in premiums (3% y-o-y) as compared to the CAGR of 5% over 2016-2019. The growth rate was low due to stagnant growth in the business insurance segment, which contributes roughly 52% of the total earned premiums. Further, the net investment income decreased by 10% y-o-y due to the interest rate headwinds. Notably, the interest rates have suffered due to the zero-rate policy of the Federal Reserve in response to the Covid-19 crisis.
The insurance giant posted better than expected results in the recently released first-quarter FY2021 results. It reported revenues of $8.3 billion – up by 5% y-o-y. This increase could mainly be attributed to a 15% y-o-y gain in net investment income, which benefited from higher average investments, partially offset by a lower interest rate environment. Further, total premiums in the quarter were 2% higher than the year-ago period. While the business insurance premiums continued to suffer in the quarter, growth in bond & specialty and personal insurance premiums was able to offset the decline. That said, the low-interest rates are likely to stay for some more time. However, growth in investment assets is expected to offset some of the impacts of lower rates on net interest income. Further, with recovery in the economy, business insurance premiums are likely to see some improvement in FY2021, boosting the total earned premiums figure. Overall, the TRV’s revenues are expected to touch $33.6 billion in the year.
The net income margin is likely to see a slight increase in FY2021, which is likely to improve TRV’s profitability figures for the year – EPS will likely improve from $10.52 to $11.65. The EPS of $11.65, coupled with the P/E multiple of just below 14x will lead to a valuation of around $162.
Finally, how much should the market pay per dollar of Travelers’ earnings? Well, to earn close to $11.65 per year from a bank, you’d have to deposit about $1165 in a savings account today, so about 100x the desired earnings. At Travelers’ current share price of roughly $160, we are talking about a P/E multiple of just below 14x, which is appropriate.
That said, insurance is a risky business right now. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?
TRV, like other insurance companies, is dependent on the income from investment of insurance premiums for its profitability – It has around $84.4 billion in invested assets (as per FY 2020 data). Hence, any further worsening of the economic conditions or a sudden jump in the Covid-19 case count can lead to a further decline in investment yields. Additionally, deterioration in the economic scenario will likely harm the insurance premiums as well, as people are more focused on near-term survivability in the time of crisis. To sum things up, we believe that Travelers stock is marginally undervalued and offers limited upside.
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