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21st Century Insurance (Ticker Symbol: TW) is the largest direct-to-consumer auto insurer in California, with 7% of the state's overall auto insurance market, and roughly half of the direct market. Basically, they sell insurance directly to consumers, rather than hiring agents. This keeps their costs low and allows them to charge less than their competitors.
Their low cost structure should lead to market share gains, as consumers warm up to the idea of purchasing insurance directly. While older drivers like to have an insurance agent, young people are switching to direct insurers. In my opinion, the direct-to-consumer market will gain significant market share over the long term. This, in turn, should lead to decent growth. You should note, however, that the company earns low returns on equity, which means that this growth (if it occurs) will not add much to shareholder value. So, even if the company grows significantly, it does not deserve to trade at a high valuation.
Predicting earnings for this company is a little tricky. As an auto insurance company, its earnings could vary widely. Underwriting profit margins could be 15% one year and -5% the next; interest on the company's bonds could be 3% at one time and 10% at another. To get a stable earnings estimate, I would recommend the following: take the company's revenues, multiply that by 2.5%* (or whatever you expect the company's after-tax underwriting profit margin to be). Then, take the total value of the company's cash and bonds, subtract its debt, and multiply that by, say, 5% (which would be the expected after-tax interest rate). In order to calculate this number, you might want to look at the historical yield on 5-year, high grade bonds.
Doing so for 21st Century Insurance, we get:
1246*.025 + 1148*.05=88.55 million.
Dividing that by the number of shares that are outstanding, which is 85.48 million, we estimate that, under average conditions, the company will earn $1.04 per share. At the current price of $12.97, this results in a P/E of 12.47.
If you expect an underwriting profit of 2% and an interest rate of 4.5%, you get an expected earnings per share of $0.89. This translates to a P/E of 14.57.
But there are a some risks. Here are the main ones that I see:
1)California's insurance commissioner is elected by the public, and the public hates insurance companies. Consumers almost always feel that insurance companies are ripping them off, whether or not it's true. As a result, insurance commissioners are politically motivated to act against the interests of insurance companies, to the extent that the courts will allow. This will likely prevent the company from earning above average returns on equity, and could cause other problems as well.
2) The company used to offer earthquake insurance, and the 1994 Northridge earthquake nearly bankrupted the company. The claims from that event continued for years, and there is still some potential liability from that today.
3) Like any insurance company, they could be underreserving (that is, future losses may be higher than they expect). The company has recently expanded into other states (such as Arizona) and they might be underestimating future claims in those areas. If that's the case, they might be under pricing their policies, which could lead to huge losses in the future.
4) The company's bonds have an average maturity period of about five years. If interest rates rise significantly, the value of these bonds will fall, and consequently, the value of the company's equity will decrease. If this is combined with another serious issue, it could cause problems.
*The 2.5% figure expects a 4% pre-tax margin. This is the target of many auto-insurance companies, including Geico and 21st Century. It is lower than the margin that auto insurance companies have averaged over the long term, and it allows them to earn an average (or "fair") return on equity, which is what regulators will allow. Because of this, I see the 2.5% after-tax margin as reasonable.