Lancashire Holdings (LON:LRE) has built an excellent reputation amongst investors and analysts. Since floating the company has focused on shareholder returns over growth and has returned 190% of capital raised in its 2005 IPO. Cumulative ROE since that point is an impressive ~250%.
In the past six months, Lancashire seems to have fallen out of favour with the market. Taking into account the substantial distribution to shareholders – the company paid out 69p in March, 7.6% of its price at that point – the share price has lagged the market by around 13%.
Given the reputation that the company and its leader, Richard Brindle, have built up over the past eight years it is worth looking more closely at what factors have driven this under-performance and whether an opportunity has been created for investors.
Explaining Under-performance
First, insurance markets are softening dramatically. Softening has been driven to a large extent by third-party capital. Guy Carpenter estimates that $10bn of third-party capital has entered reinsurance markets over the past year and a half and now accounts for 14% of the global property limit. Premium declines in some property lines have approached twenty percent in mid-year renewals. In retrocession lines, Lancashire started the Accordion sidecar in response to favourable retro rates in 2012, declines are nearer thirty percent. As seen in the Q2 report Lancashire’s response has been to pull back rather than chase the market down.
Second, Lancashire recently announced the acquisition of Cathedral, a Lloyd’s insurer. To date, Lancashire had eschewed acquisitions as a way to create value. Although the opening pages of the 2011 Annual Report did make clear that it would consider them at the right price. Nonetheless, Lancashire has moved into uncharted territory with this move and investors may wonder whether the company has lost its focus.
Both of these factors are, in my view, legitimate and investors should take them seriously. The danger is that investors simply think: “Richard Brindle is great” + falling price = profit. The first point is certainly true to some degree, Brindle does have a fantastic underwriting record. At the same time, insurance is a highly competitive industry and Lancashire cannot escape the effects of their competitor’s actions. When competitors become more aggressive, Lancashire must pull back.
Investment Case for Lancashire
The starting point, for me, is always valuation. From this we…
