I like this auto insurance company since it is Progressive

Traditional auto insurance companies are not the most desired investments currently. It’s all too easy to buy all these sexy new insurtechs around the corner (via your commission-free trading app). Advertising (or listing) your company as a tech company that could/would/should grow it’s revenue/users/losses by 10/20/50x is all the rage now. If that is what ‘investors’ want, that’s what they get …

I took a look in the other direction and in this post I will provide an update on The Progressive Corp. and it’s shares PGR US. I have to admit, there is not much I do not like … (biased?)

This is not investment advice. Please read the disclaimer.
I do currently own shares of the discussed company (Progressive).

The pandemic resulted in a strong tailwind for auto insurance companies’ profits. Due to much lower traffic, frequency of accidents was much lower, resulting in much lower losses. Progressive (and other insurances like Admiral in the UK) took a long-term perspective, like crediting customers 20% of their premiums in May/June and handling things more flexibe. These companies send the message We’re here for you.

Sugercoated loss ratios and ytd results have to be taken with a grain of salt, but underlying trends are strong nonetheless. PGRs combined ratio, loss ratio and expense ratio are well in order, despite historically high catastrophe losses, continuing high acquisition costs and increased expenses in the commercial segment (read about insurance basics here).

own spreadsheet (property ER, CR include ARX amortization)

Progressive continues its growth trajectory. As stated in its interactive 2020 Q3 shareholder report, Progressive’s ‘preferred measure of growth is in customers, best measured by policies in force‘ or PIF. The company grew its PIF to 24.4m in September by +10.7% yoy, exactly in line with a CAGR of 10.7% from 2016 to 2019. The company strongly increased its (data-driven) marketing spend in Q3 (+29%, +20% ytd), which is a driver for further customer acquisition.

own spreadsheet

More efficient operations is an important goal. Higher acquisition expenses are an important growth driver and can deliver long-term shareholder value. But lower non-acquisition expenses are a strong sign that progressive’s operations are indeed getting more efficient.

Read my initial analysis of Progressive
for a better understanding of its strategy!

Aligned employees are a key component for PGR’s success. Tricia Griffith was previously head of HR before becoming Progressive’s CEO and started her career at the company as a claims rep. She knows the company’s operations and how to care for her colleagues. The goal is to make Progressive the top-rated corporation for diversity and inclusion. Diversity can actually help to improve risk evaluation (many studies claim better results for mixed teams) and various processes.

A smart capital allocation should be a goal for all CEOs. Progressive wants to ensure be able to ‘underwrite all the profitable insurance available’ to them. Managing its leverage, investments and its underwriting capacity efficiently is very important for long-term shareholder returns. PGR wants to use ‘underleveraged capital to repurchase shares and pay dividends’. The communicated increased special dividend of $4.50 (+100%) is proof to a smart capital allocation in the above sense. The special dividends might actually be the reason for many investors to shun PGR, i.e. if they screen for steadily growing dividends. I prefer smart capital allocation.

What’s not to like?

Disruption risk might be possibly (nowadays). If you build a company from scratch, today, you could implement much better digital processes without any legacy systems. Such companies should (theoretically) be able to offer a much better product (service, pricing, etc) disrupting industry incumbents. Examples within the insurance industry include Root and Lemonade. In practice, disrupting the mature insurance businesses of Progressive is not easy. Besides a focus on high quality services through motivated and trained amployees, PGR offers more innovative products as well (i.e. UBI) and it uses modern channels and marketing. Further, Progressive uses a strategy, borrowed from the Telco industry: bundling. If you have your fixed line and your mobile contract at the same carrier as a bundled contract, you are less likely to switch. The same is true, for PGR’s 1.5m Robinson customers, who have auto and property insurance with Progressive. Many start-ups active in online-lending or insurance close shop due to losses, experience has some value in these businesses. Another factor for mitigating disruption risk is Progressive’s agency business and it’s targeted customer segments (more stable clients). There commercial insurance is also doing very well.

Progressive’s investment returns will be lower with historically low interest rates. US insurances can allocate more capital to higher-yielding investments like equity, infra-structure or PE when compared to German insurances, but the majority of investments is in short-term bonds. Total investments will likely grow with PIF and property insurance business.

Auto insurance premiums could see rising competition pressuring margins. Frequency is on a long-term down-trend but could be overshadowed by rising severity with ever more technology in our cars. More technology and self-driving trends could represent additional special disruption risk-factors in the very long-term. Some OEMs might pursue to sell insurance on their own. Again, here it helps that Progressive is not only after the most fickle customers, that only care for the lowest price (Sams).

Valuation and conclusion

Progressive trades with a market cap of $ 57bn (so a significant edge isn’t that likely) based on a per share price of $97, as of Dec 16th. PGR trades for a 2020 13.7x P/E and a 5% dividend yield.

Ytd numbers are positively skewed, but underlying earnings should be higher than last year and next year’s numbers will be better than this year’s ‘normalized’ earnings. I estimate a 2021 net income of $4bn for a forward P/E of 14.3x, based on a combined ratio of 91% ( 70% LR + 21% ER). Further, I assume net premiums earned (NPE) of $ 44.2bn based on 11% annual growth this year (despite a current bump in Oct NPW growth) and 10% next. These near-term assumptions should be approximately right.

For a defensive, higher-quality business, that is growing profitably and paying (smart) dividends, that is a price (7% earnings yield) I want to own the business for, hopefully for the long-run.

I added to my PGR US position end of November and early December.
(For whatever reason the price trended downwards. I could not reach it’s (IR) website for some days.)

November update (released 18th Dec) shows a nice uptrend yet again, after a bumper (mostly in agency channel). Look at the commercial business, PGR’s execution with winning truckers is stellar. YTD results are nicely on track.

Further reads

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