Expansion Into Earthquake, Casualty, And Crop Segments Will Diversify Specialty Insurer

Key Takeaways

• Strategic acquisitions and growth in high-yield segments aim to diversify income and enhance revenue, reducing vulnerability to traditional cycles.
  
• Scaling through talent and infrastructure investment aims to drive long-term growth and operational efficiency, improving margins.
  
• Elevated catastrophe losses and volatility in certain categories, coupled with revenue challenges and diversification risks, could strain margins and earnings stability.

Catalysts

A specialty insurance company, provides property and casualty insurance to residential and businesses in the United States.

• Palomar Holdings plans to achieve strong premium growth across their portfolio, especially in Earthquake, Casualty, and Crop segments, which are expected to generate strong risk-adjusted returns. This focus on high-growth areas is likely to impact revenue positively.
  
• The company is actively diversifying its business through strategic acquisitions and organic growth, such as the purchase of First Indemnity of America Insurance Company and expanded growth in the Crop business. These efforts are expected to enhance revenue and earnings by providing new sources of income that are less vulnerable to traditional P&C cycles.
  
• Palomar is committed to delivering consistent earnings through the reduction of volatility in their portfolio, evidenced by their adjusted net income growth and return on equity despite elevated catastrophe losses. This approach is anticipated to stabilize earnings and potentially improve net margins.
  
• The company has a strategic imperative to scale its organization, which includes investments in talent acquisition and infrastructure to achieve their Palomar 2X objectives. This scaling is expected to drive long-term revenue growth and improve operational efficiency, thereby potentially enhancing net margins.
  
• Palomar is leveraging reinsurance market dynamics, such as excess capacity due to non-renewals by competitors, to achieve favorable pricing for their own reinsurance. This strategy could reduce their reinsurance costs, potentially improving net margins and boosting earnings.

Palomar Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Palomar Holdings's revenue will grow by 22.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 21.6% today to 23.1% in 3 years time.
• Analysts expect earnings to reach $212.0 million (and earnings per share of $7.37) by about December 2027, up from $108.5 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 17.6x on those 2027 earnings, down from 27.1x today. This future PE is greater than the current PE for the US Insurance industry at 12.9x.
• Analysts expect the number of shares outstanding to grow by 2.82% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.92%, as per the Simply Wall St company report.

Palomar Holdings Future Earnings Per Share Growth

Risks

• The company experienced elevated catastrophe losses this quarter due to hurricane and flood events, which could continue to impact net margins if similar events reoccur and if risk management measures are insufficient.
  
• There's ongoing high volatility in the Inland Marine and Other Property categories, particularly in the All Risk book, which has been the primary driver of catastrophe losses. This could negatively impact earnings if not managed or reduced further.
  
• The cessation of a Fronting partnership led to an 11% decline in premiums, indicating potential challenges in maintaining revenue streams if new partnerships do not compensate for lost business.
  
• The plateauing of commercial earthquake insurance rates, combined with increased competition, particularly from new capacity in the market, might constrain revenue growth in this line.
  
• Rapid growth and expansion into new lines such as casualty and crop insurance, while beneficial for diversification, introduce complexity and risk, potentially impacting net margins due to the need for significant investments in underwriting and claims management capabilities.

Valuation

• The analysts have a consensus price target of $112.33 for Palomar Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $136.0, and the most bearish reporting a price target of just $100.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $916.2 million, earnings will come to $212.0 million, and it would be trading on a PE ratio of 17.6x, assuming you use a discount rate of 5.9%.
• Given the current share price of $111.15, the analyst's price target of $112.33 is 1.1% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.