Is the Travelers Selloff an Opportunity Buy or a Value Trap?

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Travelers Cos. Inc. (NYSE:TRV) has long been a stock that I held up until several months ago, when I booked profits to reallocate into other names. I want to be clear: I think it’s a great company, and the stock is still cheap. However, when any stock grows to a high share price, it mathematically obviates that it will represent a larger percentage of your holdings. That was my impetus for selling. It turned out the timing was appropriate, as its most recent quarter was painful. Before discussing the quarter and why I think it may be a decent opportunity, let me provide some background.

Travelers provides various commercial and personal property, as well as casualty insurance products and services to businesses, government units, associations, and individuals primarily in the United States. It operates in three segments: Business Insurance Financial; Professional, and International Insurance; and Personal Insurance.

The Business Insurance segment offers property and casualty products, such as commercial multi-peril, commercial property, general liability, commercial auto, and worker’s compensation insurance. The Financial, Professional, and International Insurance segment provides surety and financial liability coverage, which uses credit-based underwriting processes; as well as property and casualty products primarily in Canada, the United Kingdom, and the Republic of Ireland. The Personal Insurance segment offers property and casualty insurance covering personal risks, primarily automobile and homeowners insurance to individuals.

As you can imagine, like other insurance companies, such as Allstate (NYSE:ALL), the company makes money by bringing in premiums and paying out as little as possible. Allstate has long been successful, as has Travelers. But, this past quarter, there were some extenuating circumstances for insurance companies like Allstate, as well as Travelers and its competitors. Travelers was hit particularly hard by extreme weather and catastrophe losses.

The quarter was rough for Travelers, but I think it was an anomaly. The company reported net income of $683 million, or $1.95 per diluted share, compared to net income of $925 million, or $2.41 per diluted share, in the prior-year quarter. Operating income in the current quarter was $673 million, or $1.93 per diluted share, compared to $816 million, or $2.13 per diluted share, in the prior-year quarter.

As I alluded to above, both net and operating income were substantially lower due to higher catastrophe losses, while the prior-year quarter further benefited $122 million after-tax from favorable tax and legal settlements. In addition, net income in the prior-year quarter benefited $87 million after-tax from net realized investment gains related to a short position in U.S. Treasury futures contracts. So the comparability is a touch biased.

On the other hand, the quarter benefited from a strong underlying combined ratio and solid investment performance. Written rate gains were spot on. They pretty much were in line with expected loss cost trends in Business Insurance and exceeded expected loss cost trends in the Financial, Professional, and International Insurance and Personal Insurance segments. Further, there were record quarterly net written premiums of $6.2 billion, up 6 percent from prior-year quarter.

Looking ahead, I think the stock is an opportunity buy. It is trading at just 8 times earnings, whereas rival Allstate trades at 12.5 times earnings. Travelers also has paid shareholders $1.066 billion in the last quarter, including $876 million in share repurchases. Year-to-date total capital returned to shareholders is $1.948 billion. In the quarter, increases in book value per share were 7 percent to $75.32. Of course, the stock trades at a premium, but I think it can go higher. I booked profits at the end of May, but if this pullback continues, I strongly recommend buying stock of this high quality company.

Disclosure: Christopher F. Davis holds no position in any stocks mentioned and has no plans to initiate a position in the next 72 hours. He has buy rating on Travelers and a $105 price target.

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