Monday, August 8, 2011
Hartford Financial Services Q2 & Sell
As the initiating and covering analyst, it is my opinion that the Hartford Financial Services (HIG) should be sold. Despite its eye-catching absolute valuations, the release of Q2 and the corresponding conference call depict a company that is now less attractive in terms of performance, outlook, and valuation. HIG has also crossed below its stop loss.
Performance: Hartford Financial Services announced Q2 earnings inline with their pre-announced numbers. The preliminary release was intended to soften the impact of six uncommon items that reduced after tax net income by $538M. They were (after tax): catastrophe losses of $290M, an asbestos related reserve increase of $206M, A charge of $73M for a discontinued software project, A negative DAC unlock charge of $21M, and A tax benefit of $52M million related to a resolution of a tax matter with the IRS. This turbulence, and the announcement of a $500M share repurchase authorization have clouded the essential issue. The Hartford’s post 2009 improvements have not kept pace with their competitors, or the domestic economy. Of their eight segments, only the global annuity business has posted increases in both revenue and operating margin from the first six months of 2010 to the corresponding period of 2011. These stagnant results have created rumors that management will have to start selling non-core pieces of the company. Bloomberg has reported on rumors that the mutual fund business will be the first to be sold.
Outlook: Given the nearly flat results of first half in 2011 and the uncertain macroeconomic conditions going forward, it’s unsurprising that HIG will not reach its internal targets. Management’s primary goal for 2011 was to close the gap between their relatively high cost of capital and their industry lagging ROE. CEO Liam McGee framed the issue this way, “we targeted an 11% ROE run rate for the company by the end of 2012. We remain committed to increasing ROE, but given the impact of the macroeconomic environment on some of our original assumptions, we now expect it will take longer to reach the 11% goal… [T]he economy has grown more slowly than we anticipated then, and interest rates have remained at historically low levels.” On a segment specific level, this means the P&C divisions are not expected to grow significantly and the variable annuity division is not yet fully operational. The new products that were announced in June have only been active for a month and there are still offerings awaiting approval from the SEC. HIG is also exposed to a fair amount of sector and industry risk as the market is still grappling with the repercussions of sovereign downgrades.
Valuation: When HIG was pitched in early April it was one of the few insurance companies that was trading at a significant discount to book value. However, the combination of solid performance by the life insurance sector and the general market decline has increased the number of companies trading under book value. When money starts to flow back into the financial sector, whenever that maybe, it seems more likely that buyers will find the handful of industy leader that are trading under book to be more compelling than Hartford, specifically PRU(.81), MET(.72), LNC(.54), TRV(.88), and ALL(.72).
Ultimately, I feel that redirecting the funds now will take advantage of UASBIG’s speed and flexibility to avoid risks and refocus on more appropriate areas of the financial sector.