辛辛那提金融公司:我正在等待的股息王

SeekingAlpha · 2020-09-17
This puts CINF in the rarified air of Dividend King, having passed the threshold of 50 consecutive years of dividend growth a full decade ago ... The Dividend King of Cincinnati Has it Covered 60 years is a long time to do anything, and to an income oriented investor, 60 years is a very long time to never miss an annual dividend increase ... Having held Dividend King status for so long it is a safe bet that CINF will jump through a lot of hoops to ensure that the dividend continues to grow, at least at a nominal rate, so as not to loose that distinction.
Summary

Cincinnati Financial Corp. has one of the most impressive dividend increase streaks around, at 60 years.

That streak backs up a solid, and well covered, 3.12% dividend yield at current cost.

The COVID related headwinds that have impacted the business in 2020 are not permanent, and won't derail a strong company like CINF.

Premium revenue growth that has outpaced industry peers looks poised to continue.

Value concerns are enough to temper the excitement around this income investment play.

Investment Thesis

Cincinnati Financial Corporation (CINF) currently yields a 3.12% dividend that has seen 60 years of growth. This puts CINF in the rarified air of Dividend King, having passed the threshold of 50 consecutive years of dividend growth a full decade ago. As an income investor this alone is enough t make me stop and take a longer look. In the case of CINF, it is any anything but a cut and dry decision when it comes to opening a position in the current climate, and at current valuations.

On the surface the recent numbers have not been pretty. A solid Q2 2020 only served to blunt the impacts still being felt from a Q1 that saw income come in at -$1.226B and earnings per share (EPS) of -$7.56. While those numbers are, mildly put, awful they also hide some underlying strengths that make CINF a very interesting candidate to add to an income portfolio.

The real problem with CINF right now, as I see it is valuation. By my estimations the stock sits very close to the fair value line, leaving very little safety margin in opening or growing a position at the current price, which as of this writing is $76.92. At this price I am taking a neutral stance on CINF and waiting on the price to dip before buying this King.

A Word On Income

Before we dive into both sides of the argument regarding CINF, I want to address the income fluctuation in 1H 2020. CINF has a sizable portfolio of equities it carries on its balance sheet totaling over $19.4B. By virtue of accounting rules and regulations CINF is required to report gains and losses in fair value of holdings on the income statement. With such a large portfolio, and the market volatility of the first half of the year, some rather wild swings were reported by CINF. As you can see on the graph of the S&P 500 index performance for Q1, quarter end was near the bottom of the pandemic sell off. The result was that for the quarter CINF had a loss to report of $1.729B on investments.

Source: YCharts

The second quarter of the year saw the bounce and “V-shaped recovery” we had been promised, as the same index popped to the tune of 25.49%, and drove a gain in the CINF portfolio of $1.06B. So, while on paper the portfolio is down $669M, the realized gains and losses are significantly lower as at no point did CINF sell the entire portfolio and lock in those changes.

Source: YCharts

I point this out for a few reasons. The first is that I, personally, think it is ridiculous that a company managing a large portfolio should report unrealized gains and losses on the balance sheet alongside very real profits and losses. I don’t report the increase in value on my house or in my portfolio every year on my income taxes. Secondly, I want to highlight this, as it is extremely important context for the rest of the discussion regarding CINF. This is the main reason I will talk about free cash flow (FCF), specifically as calculated as Cash From Operation less Capex, as opposed to total revenues. It is also why I will discuss revenue from earned premiums and operating income, while intentionally excluding the gain/loss of fair market value of equities that is reported as part of net income.

You may disagree and believe that it is important to incorporate that piece of the balance sheet into the analysis, and that is fine. If so, I encourage you to make that a part of your due diligence in evaluating CINF, and any other company that has to report these types of “gains and losses”. I will also give fair warning, I won’t be including it in any of the below.

The Other Elephant In The Room – COVID Business Impacts

The coronavirus pandemic has had far reaching impacts on businesses large and small, and the insurance industry has seen some very unique costs. Aside from moving work forces out of offices and setting employees up to work from home for extended periods, insurance companies like CINF have also had to make billing and policy adjustments where appropriate to serve policy holders through these difficult times.

Source: Cincinnati Financial Corporation Q2 Investor Presentation

A great deal of us received credits from our auto insurance companies in the early months of the lockdowns as an offset for the significantly reduced mileage we were driving. Cincinnati Financial provided this relief to its personal lines auto policyholders; issuing 15% credits applied to April and May premiums, totaling an expense of $16M. The above slide from the Q2 investor presentation from CINF outlines this and other actions taken in response to the pandemic. Among some of the other relief policies offered that will cause short term earnings and revenue pressures are the pausing of cancellations for non-payment, waiving many late fees, providing credits for policies on idle commercial vehicles, and increasing underwriting expense risk by allowing policy holders to perform deliveries to better serve local communities.

I don’t disagree with any of these policy initiatives, and I think you would be hard pressed to find someone that does. I also am not concerned about the impact they are going to have on CINF. I see these as short term impacts to revenue and earnings that growth and a strong business will move past quickly. As we sit on the down side of the third quarter, I anticipate that a good deal of these headwinds have already passed.

The below slide from the same presentation calls out some additional financial impacts felt in Q2 that are directly linked to the pandemic.

Source: Cincinnati Financial Corporation Q2 Investor Presentation

While premium growth slowed to 6% from 10% in Q1 the impact is not terrible, and the uptrend in new business submissions in the quarter suggests that the 6% figure was weighted down by early Q2 performance. If, in fact, the quarter finished on an upward trajectory for new business submissions, implying further premium growth, it is reasonable to assume that Q3 and 2H20 have the potential to land with premium growth above that Q2 mark and more in line with the 10% growth form both Q1 and whole year 2019.

The last several points on that slide have drawn a great deal on conversation in recent months regarding CINF, specifically around the business interruption claim language in policies, and the underwriting expenses and legal expenses that could arise. In Q2 those two pieces alone accounted for $43M of the total $65M in pandemic related losses. That is a full 66% of pandemic attributable losses belonging to either the claims paid out ($24M) or the legal expenses incurred in response to claims ($19M) filed for business interruptions due to COVID.

While CINF points out in that slide that in order to be paid out the claims have to show direct physical damage or loss to property, the language in the majority of the policies issued by CINF does hot have specific language that excludes claims or damages related to viral or bacterial causes, as most other Property and Casualty insurance (P&C) companies include. This leaves CINF potentially exposed to far more valid claims, and even more litigation around claims, than it’s peers are due to business interruptions from COVID. This is, in my opinion the largest question mark related to the recent impacts that CINF is facing, and where I will be looking for more clarity during the Q3 earnings report and presentation.

A final Q2 impact to address, though not COVID related, is the operating income drop of $69M. This was a 49% decrease in operating income for the quarter that was driven by $79M in higher catastrophe losses that were related directly to weather or civil unrest. Those additional losses make up the entirety of the decrease in operating income, and if backed out for comparison purposes operating income would have seen a bump. Such is the nature of the insurance business. Occasionally the payouts will exceed even the best estimates.

Core Business Revenue Continues to Grow

Source: Graph is the Author’s. Data From Seeking Alpha

As discussed earlier, net income is seeing some serious impacts in both directions based on the performance of the investment portfolio, but the core business is insurance. That being the case the core revenues are from premiums and annuities. I think it’s important to be grounded in what the recent past and projected future of that stream of revenue look like. Above is a graph of those revenues from the past 11 quarters. While there are some jagged lines the absolute growth from Q4 2017 through Q2 2020 is 15.74%. If we take a slightly longer view of premium growth the 5-year CAGR is 5.9%, which exceeds the industry CAGR over the same period by 0.9%. So while the annualized growth isn’t eye popping, it certainly is sitting above the rest industry average.

In terms of continuing the premium growth, CINF presented the following at the end of Q2, laying out a roadmap for continuing the upward premium revenue momentum.

Source: Cincinnati Financial Corporation Q2 Investor Presentation

The overall strategy to continue premium growth centers around continuing to add new agency appointments, which proved successful n 2019, as well as expanding marketing and services to high net worth clients. In Q2 alone those efforts to the high net worth client base resulted in a 24% increase over 2019. The third piece to the growth equation is renewal pricing. Across commercial lines, personal lines and E&S the renewal pricing was up mid-single digits. What CINF has is a plan in place that should pave the way to continue to match, if not exceed, the growth rates across the industry over time.

The Dividend King of Cincinnati Has it Covered

60 years is a long time to do anything, and to an income oriented investor, 60 years is a very long time to never miss an annual dividend increase. CINF has done just that. Doubling up on the time it takes to be named a Dividend Aristocrat, and adding another 10 years for good measure. It takes an unwavering commitment to continuing to return higher levels of income to loyal investors, and is hard to ignore for anyone looking to add secure income to a portfolio.

While a great track record of increases, and this is one of the best, is on the top of the list for those of us seeking passive streams of income, continued security in the payout is also of great importance. Fortunately for anyone long CINF, the dividend is well covered.

Source: Chart is the Author’s. Underlying data from Seeking Alpha

The above graph shows the free cash flow, calculated as cash from operations less CAPEX, significantly outpacing the dividend due to investor’s quarter over quarter. The payout ratio as a function of the companies FCF has been below 50% for all but two of the past eight quarters. It is evident that CINF is generating cash sufficient to cover the dividend on an ongoing basis.

For more proof that the dividend payout is safe, and in a comfortable range I am including another slide from the Q2 CINF investor presentation. They have provided a view of the declared dividends charted on both operating income and net income. 2017-2019 net income have special circumstances called out on the slide driving the per share number up and down over that time, so the operating income is a steadier indicator for us to look to.

Source: Cincinnati Financial Corporation Q2 Investor Presentation

When we look at operating income from 2015 through 2019, on a per share basis, the dividend is covered in each of those years. Net income in 2017 and 2019 were significantly impacted to the positive by areas outside of operations (2017 by tax reform and 2019 by significant investment gain). Conversely 2018 had a negative per share net income impact from net investment losses. For me, the takeaway here is that income from operations has been more than enough to continue to pay, and increase, the annual shareholder dividend payout.

Dividend Growth

With the dividend safely covered at the moment continued dividend growth is the next factor I am looking at. Having held Dividend King status for so long it is a safe bet that CINF will jump through a lot of hoops to ensure that the dividend continues to grow, at least at a nominal rate, so as not to loose that distinction. But, I am not looking to see 1% growth annually on a 3.12% yield. I fully understand that the days of double digit dividend growth are likely behind CINF, but I feel confident that the future growth will be in the 4-6% range for at least the next several years. And likely between 4-4.5% for the next increase based on current payout ratio relative to operating income and FCF generation.

I am further convinced this is an accurate estimate based on the recent acceleration in dividend Growth CAGR.

Source: The Author

The annual growth rates for the dividend have been accelerating as we shrink the time frame, indicating that growth has picked up over those intervals. While I find the near 7% increase to be high based on the current climate, I do think the numbers support mid-single digit increases going forward. As outlined earlier, CINF is covering the dividend on a quarterly basis with less than 50% of FCF save for just two of the past 10 quarters, and payout when measured against operating income is equally attractive. I even hold out hope that future dividend increases will be closer to the 3Yr CAGR than my near term estimate of sub-5% growth as headwinds from COVID business claims and litigations are settled, but I am not going to make those assumptions just yet as I prefer to be more conservative here.

The Value Problem

So far CINF looks great. Income from operations is strong. The core business revenue from premiums is on solid ground and showing growth that out paces peers. Cash generation is strong and covering a nice dividend yield with a best-in-class streak of increases. But it isn’t all sunshine and rainbows. I believe that the current valuations on CINF are too high to be an attractive buy. At the time of writing the stock is trading at 22.9x earnings. While this isn’t out of line with the total market valuations, it certainly stands out when compared to other P&C companies.

I used The Allstate Corporation (ALL), The Progressive Corporation (PGR), Chubb Limited (CB), and The Travelers Companies Inc. (TRV), as comps during my analysis, and while CINF stacks up well overall against all of these companies from an investors view, value is where the biggest gap is. Only CB is trading at a higher multiple to earnings at 25.27x than Cincinnati Financial. All of the other comparable stocks are well below that multiple; ALL is at a 7.03, PGR 12.75 and TRV 16.18.

Future earnings multiples paint a similar picture, as CINF is trading at 20.43x future earnings, higher than any other company in that peer group. Allstate has a forward multiple of 8.09, Progressive’s is 17.30, Traveler’s came down to 10.96 and Chubb’s is 11.01. Granted all of these are forward numbers based on projected earnings, and depending on the estimate used can vary, but the picture is rather clear, CINF is trading at a premium to earnings versus comps.

A case can certainly be made that the multiple is higher because of better than industry average premium growth, or a more attractive dividend yield and history, placing a premium on the stock. I would have a hard time completely disagreeing with that logic, and would likely have to fall back on the fact that the premium is higher than I think are warranted.

How Wide is the Value Gap?

Having higher P/E ratios both current and forward does indicate that CINF has a high valuation, but it is important to try to determine if the valuation leaves any safety margin. To do this I considered two factors; the first is a look at price relative to the 5-year average dividend yield, and the second is a future price estimate based on forward P/E and EPS growth estimates.

Looking at the first, the 5-year dividend average comparison, CINF appears to have some upside. The 5-year average dividend yield for CINF is 2.68%, and the yield as of this writing is 3.12%. Doing the math based on those yields the 5-year dividend driven fair value price lands at $89.55, putting CINF at a 16.42% discount to that price. Now, before saying this indicates a buy, I will point out that this metric, while valuable, is not perfect and I don’t make any decisions based solely on this number. But I do find it to be a useful way to start a fair value analysis of any company with a long dividend history.

The next metric I am looking at here is the forward price based on forward P/E and EPS growth estimates. Taking the forward P/E of 20.43 and the EPS growth estimate of 17% we land at an $80.31 price target. This is a great deal skinnier than the margin provided by the previous number, and indicates a far less attractive price.

Taking a simple average of those two estimates gives a possible fair value price of $84.93, representing about a 10% discount to fair value at current. This falls just about at the boarder line, though a bit low, for me to consider it a good buy.

Conclusion

Cincinnati Financial Corp. checks a lot of boxes for a buy and hold income investor. It is a company that has managed to increase the dividend payout for 60 years, and still offers a yield over 3%. The dividend growth rate, while not setting the world on fire by any means, has shown acceleration over the past 10 years and more than kept up with inflation. Forward growth projections suggest that dividend growth rate will continue to outpace inflation as well.

The growth in the core business, premium growth, is steady and above the industry average, highlighting the strength of the business. This growth is driving solid operating income and cash flow numbers that support the dividend and allow for re-investment in the business.

Further, the largest headwinds look to be temporary in nature and not flaws in the overall business. While CINF has a seemingly unique exposure to business interruption claims from COVID impacts in the industry due to a lack of specific language in corporate policies, those costs are not going to be ongoing in nature. The impact to CINF from these claims is likely to be felt for longer than the other Q2 exceptional loss drivers (additional claims losses related to weather and civil unrest, personal and commercial auto policy discounts and credits, and suspension of late fees and non-payment cancellations) as claims and potential litigation resulting from those claims will very likely stretch over a greater period. That being said, they do not represent an ongoing risk to the business or a built in weakness that threatens the foundation of the company. Tying this up, I would also not be surprised if newly issued policies now include that missing language at issue, thus limiting future exposure to similar claims.

CINF falls short, in my opinion, on value. The high multiple to earnings makes it difficult to see an attractive value at this price. While the dividend yield, history, and coverage are all excellent, and the business projects forward earnings growth, I want to see a greater margin of safety in the pricing.

At $76.92 and rising I am going to be awaiting the October earnings release before seriously considering opening a position, though I will leave room for the possibility that a significant dip may create too much value to be ignored. I am looking forward to seeing if the Q3 release validates or contradicts my conclusions regarding the COVID headwinds, as well as if any price movement comes out of the results that will allow me to lock in more value and an even higher yield on cost. Until then I will be keeping an eye on the price to see if an opportunity arises, ideally below $68-72.25 .

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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