Hartford's Transformation Continuing To Unlock Value

By Stephen D. Simpson, CFA | July 08, 2013 AAA

A year ago, I was somewhat skeptical about Hartford's (NYSE:HIG) decision to transition out of its traditional life insurance and annuity businesses and towards a greater focus on P&C. While I thought the stock was cheap on a long-term ROE basis, I didn't expect the nearly 90% increase in the share price, nor the rapid pace of improvement in the company's legacy and going-forward operations. While the shares now have more average long-term potential on a ROE basis, there could still be upside left for these shares if Wall Street elects to value these shares more in line with other P&C companies with similar return characteristics.

SEE: Should You Cut Financials Out Of Your Portfolio?

All About The P&C Now
While Hartford still has sizable run-off operations (largely under the name of Talcott), the company's future is as a P&C insurance company in both commercial and consumer markets. By no means is the company starting from zero.

Hartford is the third-largest workers comp insurance company, trailing only Liberty Mutual and Traveler's (NYSE:TRV) in an industry that rewards savvy underwriters and brutally punishes those who make mistakes. Although the company has lost some middle-market business due to higher rates, this is a business where I believe the good underwriters hold considerably advantages and where Hartford can benefit with an improving labor/employment situation.

Hartford is also a top-10 auto insurance company. I don't think Hartford is going to aim for unseating Berkshire Hathaway's (NYSE:BRK.A) GEICO, Progressive (NYSE:PGR), or Allstate (NYSE: ALL), Hartford has enough scale here to make solid returns for the long-term.

Strong Run-Off Leading To More Capital Options
Hartford has gone a long way toward dismantling its old insurance operations. The company sold its individual annuities business in 2012, its individual life insurance business to Prudential (NYSE:PRU), and recently announced the sale of its U.K. variable annuities business to Berkshire for $285 million (more or less at book value). More importantly, management has announced that its remaining run-off operations are now self-sufficient with respect to capital.

SEE: The History Of Insurance

With that, Hartford is now launching a pretty significant capital return program. The company increased its share buyback program by $750 million (to $1.25 billion) and increased the dividend by 50% to $0.60/share/year.

De-Risk, De-Leverage, And Then … Grow?
As you might imagine from the sizable capital return, Hartford is in pretty good capital shape now. I would expect the capital generated by the run-off operations to go towards reducing leverage and risk in the short term.

Longer term, maybe Hartford uses this capital to fuel further growth in the P&C space. Hartford doesn't have much of an international presence, but there are still profitable areas of the P&C market where Hartford doesn't have much presence. Assuming that Hartford can maintain good underwriting margins, I would assume management would have the opportunity to either grow organically or consider select acquisitions. In either case, though, I think the company's strategy is likely to keep a lid on returns on equity for the next couple of years.

The Bottom Line
I still believe that Hartford can generate long-term returns on equity in the high single digits (around 9%), but that the next few years will likely stay in the 8% range. Even so, that long-term ROE target translates into a fair value today of about $35, which is still more than 10% above the price of the shares as of this writing. Looking at the company's return on equity relative to its book value, though, the shares may be more undervalued. If I do a regression of book value multiples and returns on equity, it seems like the fair value for Hartford (on the basis of an r-squared of about 0.8) would be around 1x tangible book value, or more than $40 per share.

All things considered, I'd be inclined to hang on to Hartford shares if I already owned them. So far, the updates and news have been trending better than expected, and the stock seems undervalued on two different metrics. Where there to be a sector-wide pullback, this could be a name worth considering as a new buy in the high $20's.

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