Markel Corporation: Undervalued And Growing (NYSE:MKL)

Markel Corporation recently reported its second-quarter earnings, and it had a great quarter, improving on a dismal first quarter. The company continues to do a fantastic job of growing the earnings premiums while lowering its combined ratio to grow the profitability of the insurance segment.

The equity portfolio rebounded for a great performance for the quarter, and the fixed-income portfolio also reported a great quarter.

Markel is often compared to a “mini” Berkshire. I can see the comparison, and it is well-warranted.

Let’s dive in and learn more about the company.

Overview

Markel Corporation, a diverse financial holding company, based out of Glen Allen, VA, reported its second-quarter earnings, and it was a good quarter for the company.

Let’s dive in and discover a little more about Markel and how it does what it does.

Markel divides the company into five different segments:

  • Underwriting
  • Investing
  • Markel Ventures
  • Insurance-linked securities
  • Program Services

A few quarterly highlights, and then we will look a little closer at each segment.

For the second quarter, Markel reported earned premiums of $1.36 billion, up year over year 13 percent. The second-quarter net investment income slipped from $111.8 million to $95.6 million from the previous year’s quarter.

The second-quarter’s combined ratio improved to 88 percent, from 95 percent a year ago. And total operating expenses rose to $1.89 billion from $1.75 billion from a year earlier.

Comprehensive income rose to $1.09 billion, or $65.75 a share, from a year ago. Compared to the previous year’s quarter of $623.3 million, $36.07 per share. Earnings per share for Markel is a fluid metric, but more on that in a little bit.

The overall total operating revenue beat expectations for a total of $3.13 billion, compared to the expected total of $2.61 billion, also up from a year ago at $2.44 billion.

So, overall a good quarter and a lot of good things to build on.

Let’s look at each segment’s performance.

Underwriting

Underwriting profits are the key to any insurance company, and Markel is no exception. Its underwriting performance for the quarter was outstanding. The company grew earned premiums to $1.306 million from $1.119 million a year ago, a 16.7 percent increase, which is pretty astounding.

Alongside those improvements were the increases in the gross premium volume of 11.5 percent and net written premiums of 11.5 percent, all of which equals a retention rate of 82 percent.

The total underwriting profit for the quarter was $157,596 million, which was an increase of 166 percent!

The overall combined ratio for Markel for the quarter was 88 percent, compared to 95 percent from the previous year’s quarter. The company reported the decreases were a result of lower expense ratios and lowered current accident year loss ratio, which is logical given the shelter-in-place orders during the quarter.

The reinsurance segment reported a combined ratio of 90 percent for the quarter compared to the previously combined ratio of 96 percent for the same period of 2019. As with the overall results of the combined ratio, the reinsurance segment also saw reductions in expense ratios and lower accident loss ratios.

The insurance segment also saw an increase in the earned premiums for Markel, driven largely by the insurance and reinsurance portion, as well as the other insurances. All combined to improve Markel’s earned premiums by 14 percent compared to the previous quarter’s results.

Investing Results

Markel reported net investment income for the quarter was down compared to the previous quarter of 2019, by 14.5 percent. Net investment income for the quarter was up 114 percent for the quarter, for a total of $911.2 million.

The decrease in net investment income was a direct result of lower short-term interest rates and lower short-term investment income. Also, Markel saw lower interest income on fixed maturity investments as it reduced exposure to fixed maturities in 2020.

Net investment income rose primarily as the fair value of the equity portfolio as the market conditions for equities improved markedly during the quarter. Of course, this follows significant declines the company experienced in its equity portfolio during the first quarter.

Moving on to Markel Ventures, the company reported increases in operating revenues from $617.1 million to $678.1 million, a 9.8 percent increase. However, those increases didn’t translate to the bottom line for the segment, and the company saw a decrease of 2.8 percent for the quarter, for a total of $79.4 million.

Marvel Ventures saw an increase in its services business, but lower revenues from the products businesses offset those gains.

Other Operations

Other operations saw increases in revenues for the insurance-linked securities and program services for the segment, to the tune of $54.5 million and $25.1 million, respectively. Increases for each segment were 17.3 percent for the ILS business and 503 percent for the program services, respectively.

Increases in the ILS operations created higher revenues from the Nephila operations, offset by the lower revenues from the Markel CATCo operations. Nephila reported increases as a result of growth in the company’s managing general agent operations. Markel CATCo operations decreased as a result of lower assets under management for 2020.

Program Services

Operating revenues for the program services segment were flat compared to the previous year’s quarter, due in large part to lower general and profit-sharing expenses for the segment.

Gross written premiums for the segment were lower by 9.7 percent from the previous year’s quarter, all a result of a run-off of one large program, as well as cancelations of in-force book policies from another large program.

Ok, that wraps up our overview of Markel’s second-quarter results.

Growth Story

Markel has multiple avenues for growth now, and into the future, I will try to illustrate those as best as I can.

Combined Ratio

One arm of profitability for insurance companies is the ability of the company to lower its expenses, which drives more profits to the bottom line. Insurance companies use a ratio called the combined ratio, which includes the incurred losses and expenses compared to the earned premiums of the company.

Markel reported a combined ratio of 88 percent for the quarter, and over the last six months, the combined ratio reported was 103 percent. The increase over the last six months is due, in large part, to COVID-19 and losses attributed to the pandemic.

Over the last five years, the company has reported combined ratios of:

  • 2019 – 94%
  • 2018 – 98%
  • 2017 – 105%
  • 2016 – 92%icat
  • 2015 – 89%

All of which averages out to a combined ratio of 95.6 percent, keeping in mind that a combined ratio under 100 percent indicates an underwriting profit.

Comparing that to the industry average of 98 percent, we can see that Markel does a fantastic job creating an underwriting profit, which not only drives to the bottom line but also offers opportunities for utilization in the investment portfolio.

Currently, Markel has an investment portfolio value of 22,227 million, with 45% in fixed securities, 25 percent in equity securities, and 29 percent in cash and cash equivalents.

Last quarter, the equity portfolio returned 30 percent, a result of the increased market conditions, and the fixed-income securities returned 6.5 percent, with an overall return of the portfolio of 14.4 percent for the quarter.

Markel reported a marked increase in net income for the quarter, due in large part to an increase in change in fair value of equities as a result of the new GAAP accounting rules that require equities to be reported at fair value for gains or losses on the income statement. Regardless of the actual sale or purchase of said investments. Not a fan of that rule, because it doesn’t reflect the reality of the performance of these portfolios, similar to the experiences at Berkshire Hathaway.

The current equity portfolio contains familiar names:

And so on… The equity portfolio is not as large as the one managed by Warren Buffett and Charlie Munger, which allows Tom Gayner of Markel to deploy his capital in companies or smaller size and find more deals to help grow income for Markel.

Markel has long chosen to invest those underwriting profits, or “float,” in fixed securities of high value that match the duration of insurance liabilities or policies outstanding.

Currently, Markel’s duration of the fixed maturity portfolio is slightly less than six years, and the average credit rating is AA. The breakdown of the portfolio equals:

  • Municipal bonds – 42%
  • MBS – 27%
  • Foreign bonds – 15%
  • Corporate bonds – 9%
  • Treasuries – 6%

That portfolio has delivered 6.5 percent returns for the second quarter.

Another aspect of growth for Markel now and into the future is the insurance-linked securities market, or ILS. ILS allows investors to allocate capital to bonds associated with other forms of insurance, such as catastrophe bonds.

With the acquisition of CATCo in 2015, and more recently Nephila, Markel has captured approximately 20 percent of the ILS market, with revenue from the insurance-linked securities coming in at $54.6 million for the second quarter and $107.7 million for the six months of 2020.

Markel Ventures is another avenue of growth for the company, in which this segment holds businesses that are, for the most part, unrelated to the insurance business.

Markel Ventures grew to $2.1 billion in 2019, an increase of 10.5 percent over 2018. Consider that since the creation of Markel Ventures in 2005, the company has grown from $60 million in revenues to the current level of 2019. That is a 26.75 percent CAGR over those fifteen years, and over those fifteen years, the company has spent $1.9 billion “cash money” to arrive here today.

Risk

As with any insurance company or any financial company that deals with interest rates currently, the continued low-interest rate environment Markel faces will continue to be a drag on earnings.

Interest rates impact the return performance of both the fixed-income securities as well as the equity portfolio, which ultimately affects the income derived from those securities – in particular, the fixed income.

However, Markel has done a wonderful job negating some of that risk by allocating a large portion of that fixed income away from shorter-term securities and their lower rates. The likelihood that those rates will be these low six-plus years from now is low, but who knows with the way things are going in 2020.

Another risk Markel faces is the upheaval in the stock market; with a substantial equity investment portfolio, there is risk involved in those equities. The risk is coming from bankruptcies, as well as the possibility of losses on any securities if they are selected for liquidation.

The final risk Markel faces is COVID-19 and the continued risks associated with insurance policies. As the virus recedes and people start moving out and about, accidents will start to creep up again – it is only natural – and the risk for Markel in those resumptions of lives is the increased level of insurance losses that will rise, causing the combined ratio to increase and profitability to decrease.

Though, Markel has done a fantastic job controlling those costs, and there has been a long tradition of outstanding performance of growing earned premiums and underwriting profitability.

Valuation

Moving on to the valuation of Markel – my favorite part.

Seeking Alpha reports a quant rating of 2.65 or neutral, while Seeking Alpha authors are bullish with a 4.00 rating, with Wall Street also with a bullish rating of 3.50

In the property-casualty industry, Markel ranks 29th out of 44th in quant rating and a sector rating of 433 out of 619 for financials.

To value insurance companies, we have several routes we could take, but based on the fact that Markel doesn’t pay a dividend, that makes us rely on more relative measures.

Price-to-Book

Price to book is one of the more useful measures of valuations for insurance companies, but something to keep in mind for Markel. As the Markel Ventures segment grows in revenue and earnings, the reliance on book value per share will diminish for Markel, as per the company via its 2019 Letter to Shareholders.

Nonetheless, for now we will carry on using the price-to-book.

Looking at the price-to-book over the last decade, we get:

  • 2010 – 1.15
  • 2011 – 1.18
  • 2012 – 1.07
  • 2013 – 1.22
  • 2014 – 1.25
  • 2015 – 1.57
  • 2016 – 1.49
  • 2017 – 1.67
  • 2018 – 1.58
  • 2019 – 1.42
  • TTM – 1.33

Averaging out those ten years of price-to-book ratios, we arrive at 1.36 price-to-book. Now, if we multiply that by the current market price, we arrive at a value of $1420.53, which gives us a 36 percent margin of safety.

From there, I would like to approach the company from a sum-of-the-parts valuation, which is a method suggested by the company in the 2019 Letter to Shareholder.

The parts that we need to sum together to find the value of the company include insurance underwriting, investments, Markel Ventures, and ILS and program services.

Let’s approach each segment individually and then sum them together.

Insurance Underwriting

Insurance underwriting recorded earned premiums of $5.177 billion TTM and assuming a tax rate of 21 percent with a conservative P/E ratio attached to the segment of 10.

Earned Premiums = $5.177 B

Combined Ratio = 96%

Tax Rate = 21%

P/E multiple = 10

Insurance Underwriting value = $1640

Investment portfolio

As per both the quarterly report and Letter to Shareholder, the investment portfolio is expecting a 6 percent equity return and a fixed maturity return for an after-tax return of 2.8%. Assigning the portfolio a return of 20 percent, which is lower than the current return of S&P 50, we get:

Insurance Portfolio = $22,227

After-tax expected return = 2.8%

After-tax expected earnings = $622

Earnings Multiple = 20

Investment Value of Portfolio = $12,440

Markel Ventures

We are moving on to one of the easier segments to value, compared to the insurance and investment segments.

Segment operating income = $79,000

Tax rate = 21%

After-tax adjusted income = $16,590

Earnings multiple = 18

Markel Ventures value = $298,620

Ok, the final piece to the puzzle is the ILS/program services segment with the trailing TTM value of $2,528.

Now we can add all of our sum of the parts up and find the value of Markel.

Insurance Underwriting = $1,640

Investment Portfolio = $12,440

Markel Ventures = $2,986

ILS/Program Services = $2,528

Debt = $3,606

SOTP Value = $15,998

Common Shares Outstanding = $13,775

SOTP Value per Share = $1161.37

Based on the numbers above, it appears that Markel is undervalued by 11.1 percent, which is a small margin of safety. When combining that by looking at the historical price-to-book, it appears that on a relative valuation basis, Markel is undervalued, and I would agree with those assumptions.

Final Thoughts

Based on the current quarter’s results and the trailing twelve-month numbers, I think that Markel is undervalued, depending on which relative valuation method is your cup of tea.

Markel, over the years, has done a fantastic job of running a profitable insurance company, to say nothing of the ability of the company to take those profits and boost them with its outstanding equity portfolio.

Many liken Markel to a “mini” Berkshire, which is not a horrible comparison and a great company to emulate.

I recently purchased shares of Markel, and I think it remains a buy up to the $1175 range.

Disclosure: I am/we are long MKL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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