Published by Bob Ciura on June 16th, 2017
2017 has been a terrible year so far for AmTrust Financial Services (AFSI).
First, it restated five years’ worth of earnings, reducing profits earned in that time by $310 million.
If that weren’t bad enough, things got even worse just one week later.
An article in The Wall Street Journal stated that secret recordings were used in conjunction with an SEC inquiry into the company, for questionable accounting practices.
AmTrust issued a response, and has insisted its books are clean, but the damage has been done. The stock has lost nearly half its value year-to-date.
On the surface, AmTrust looks like an attractive dividend stock. It is one of 416 stocks with a 5%+ dividend yield.
And, it is a Dividend Achiever, a group of 264 stocks with 10+ years of consecutive dividend increases.
While there is a great deal of headline risk hanging over the company right now, it could be a bargain, if the SEC issues are much-ado-about-nothing.
AmTrust is a property and casualty insurer. It operates in the following business segments:
- Small Commercial Business (40% of 2016 revenue)
- Specialty Risk & Extended Warranty (28% of 2016 revenue)
- Specialty Program (17% of 2016 revenue)
- Service & Fee Income (10% of 2016 revenue)
- Investment Income (5% of 2016 revenue)
The company’s primary insurance products are workers’ compensation, commercial auto and property coverage, and warranty insurance.
AmTrust went public in 2006. In the 11 years since, it has grown into a company with 125 offices in 70 countries, with almost $8 billion in annual premiums written.
It generated 81% of 2016 gross written premiums in the U.S. last year, but it is expanding its geographic diversification. The company sees growth potential in Europe and Southeast Asia.
AmTrust’s commercial business is its most important segment.
Source: April 2017 Investor Presentation, page 18
The negative headlines have taken a steep toll on AmTrust’s share price. The stock has lost nearly half of its value since the beginning of 2017.
Still, the company remained highly profitable last year. And, the company has a long track record of growth.
Insurance is a very strong business. That is because insurers make money in two ways.
First, they bring in revenue from policy premiums. Not only that, but they also make money by investing the large sums of accumulated premiums not distributed as claims, known as float.
These two revenue streams are why insurance companies can create substantial shareholder wealth over long periods of time.
AmTrust is no exception.
From 2006-2016, AmTrust’s book-value-per-share increased by 19.4% each year, on average.
According to the company, gross written premiums have increased from $526 million in 2006, to $7.95 billion in 2016. In that time, premiums have grown by 31% each year, on average.
Much of this growth is due to the company’s aggressive acquisition strategy. Since its founding in 1998, AmTrust has acquired more than 40 companies.
Over the past 10 years, AmTrust has increased its book value by over 500%.
Source: April 2017 Investor Presentation, page 4
Investment income has played a key role in this growth. From 2011-2016, investment income has grown at a 30% annual rate.
While news of an SEC investigation casts a dark cloud over the stock price, the company’s fundamentals have held up relatively well.
Diluted earnings-per-share declined 12% in 2016.
Operating earnings declined a more modest 10%. Operating earnings exclude non-cash items such as realized investment gains or losses, goodwill impairments, losses on extinguishment of debt, and foreign currency translations.
The declines were due to a reserve charge of $65.0 million, or approximately $0.24 per share, resulting from higher loss adjustment reserves in the Specialty Program segment.
Still, AmTrust remains highly profitable. 2016 operating earnings-per-share of $2.64 more than cover the company’s dividend.
Moreover, in 2016 AmTrust held a net combined ratio of 93.7%.
Source: April 2017 Investor Presentation, page 6
The combined ratio is calculated by adding incurred losses and expenses, and dividing by premiums earned.
A combined ratio below 100% indicates a company’s underwriting is profitable.
Conditions have improved to start 2017. Net earned premiums rose 14% in the first quarter. Total revenue increased 14% as well.
However, operating earnings-per-share fell 54% in the first quarter.
Nearly one-third of the earnings decline was due to higher catastrophe losses due to higher wind and hail damage in the Small Commercial Business segment.
In addition, earnings were weighed down by higher professional service fees of approximately $17 million, and a higher effective tax rate.
The big test for AmTrust is whether it can stem the decline in earnings-per-share.
To be sure, many of the factors behind last quarter’s earnings decline are cyclical, such as adverse weather conditions.
AmTrust’s earnings are also weighed down by the higher level of spending for the company to right the ship after the SEC issue. For example, AmTrust switched its auditor to a Big Four accounting firm.
And, AmTrust has made moves to strengthen its balance sheet. It recently sold its 10.58 million shares of National General Holdings (NGHC), for proceeds of $211.7 million.
Raising cash can help support the dividend, until the fundamentals recover.
AmTrust has a quarterly dividend rate of $0.17 per share. Annualized, this works out to $0.68 per share.
In addition to its high yield, the company grows its dividend regularly, at impressive rates. For example, in 2016 the company raised its dividend by 13%.
The dividend appears to be sustainable, based on the fundamental position of the company. Operating earnings-per-share of $2.64 per share easily cover the $0.68 per share annual dividend.
It would take a sustained, major decline in 2017 and beyond, to jeopardize the dividend.
However, judging by the market’s reaction this year, investors don’t seem convinced. The stock trades for a price-to-earnings ratio of just 5.3.
The cascade of negative headlines has stoked fear among investors, and the company’s weak first-quarter earnings only added fuel to the fire.
Throughout the year, AmTrust has consistently reiterated that there is nothing wrong with their loss reserves or other accounting methods. It is entirely possible the SEC probe will find no wrongdoing by the company.
The company is investing additional resources to improve its financial controls and remedy the various issues that have impacted the stock in 2017.
Meanwhile, its underwriting and investment operations continue to perform well.
If the SEC investigation comes back clean, AmTrust stock appears to be an attractive bargain on valuation, and its high dividend yield.