CNA Financial Stock: A Beneficiary Of ‘Higher For Longer’ Interest Rates (NYSE:CNA)

The Fed’s pivot to cutting rates has been put on pause, with some warning of renewed rate increases: e.g., Larry Summers recently cited a 15% probability rates would be bumped up due to entrenched inflation. If rates stay elevated for longer, what companies might benefit or be minimally damaged? P&C insurer CNA Financial (NYSE:CNA) is a company that qualifies and offers a 3.8% dividend yield. As last year showed, CNA’s net interest income (NII) was able to benefit from higher interest rates. And if rates do drop, management ably navigated lower rates during the 15 years that followed the GFC. Importantly for income investors, CNA has been able to pay special dividends to shareholders every year since 2014, in addition to growing its regular dividend at a 7.4% rate during the decade. The insurer’s underlying fundamentals and stock performance suggests CNA is a buy for its growing dividend, supplemented by special dividends, as well as potential share price appreciation.

Loews Role in the Past that Continues Today

There are not many publicly traded stocks an investor buys with 92% of the float owned by a $17B conglomerate, but, that is the case for CNA Financial. In 1974, Loews Corporation (L) “rescued” a nearly bankrupt CNA by buying 56% of CNA’s stock after the prior year’s merger with Gulf Oil fell apart. Gulf had actually agreed to acquire CNA in October of 1973. At the time, Gulf reasoned they needed to diversify into non-energy assets to lessen its dependence on oil profits vulnerable to Mid-East conflict. For CNA, a partner was a necessity after an acquisition binge begun in 1966 had eroded the company’s profitability. When Gulf aborted the agreement, CNA was ripe for a takeover and Loews saw an opportunity. By the end of 1974, billionaire CEO, Laurence Tisch, had increased Lowe’s stake in CNA to 83% stake.

Loews was pivotal to CNA’s turnaround in the 1970s, quickly cutting costs, selling unprofitable non-insurance acquisitions, eliminating money-losing insurance lines and installing new management. By 1983, CNA had divested, discontinued, or written off nearly all of its non-insurance operations; and by the end of 1990s, the company had sold off most of its personal insurance divisions (auto, homeowners, and life reinsurance). Consequently, the stage was set for today’s sole focus on commercial P&C insurance lines. For CNA shareholders, Loews 92% control over CNA’s float means vulnerability to the conglomerate’s capital allocation decisions. However, Feb 5th comments by President & CEO, James Tisch, indicate CNA’s vested interest in Loews and the inherent support the conglomerate offers:

“Given the strength of CNA’s business, I continue to find the market’s valuation of CNA perplexing. As I discussed last quarter, the company has grown substantially and has become markedly more profitable. Nonetheless, the company’s share price is almost 20% lower today than it was at the beginning of 2018. Our view is that CNA is a compelling value, and for that reason, we purchased 4.5 million shares of CNA common stock for approximately $178 million in 2023. We continue to be bullish on the outlook for CNA’s business.”

Loews brings supportive strength to CNA and its shareholders. It’s just too important to the conglomerate for CNA to not perform well. Through the years, Loews has purchased CNA’s stock when considered too low, changed management when needed and supplied cash infusions when unexpected underwriting risk has materialized. In a sense, Loews can be viewed as an insurance policy for CNA’s shareholders, or at least a ‘watch dog’ guarding against factors that could jeopardize the stock’s performance and dividend generation.

CNA’s Pattern of Outperforming Loews’ Stock

CNA’s and Loews’ stocks have displayed a pattern over longer time periods that can be instructive. The graph below shows the price-only return, as well as the total return, when annualized over the past 7 years. On a purely price basis, CNA was flat but its total return was 8% thanks to the dividend, representing a 1% outperformance of Loews over the past 7 years. Longer term, CNA’s outperformance of Loews is more stark: the 20-yr annualized total return for CNA is 6.7% compared to Lowe’s 3.1% over the past two decades.

Recently, however, the pattern of CNA besting its major shareholder has not been the case. Below is a graph depicting Loews cumulative outperformance of its subsidiary by 37% since Feb of 2021. Yes, Loews bought back 6% of its outstanding float in 2023 and the conglomerate owns a pipeline business and hotels. But, Loews biggest source of revenues and earnings comes from CNA, who is accountable for over 70% of the conglomerate’s market cap. CNA’s importance to Loews explains, in part, the two stocks’ relationship. If CNA’s returns to its pattern of surpassing Loews, it is reasonable to expect the insurer will catch up and erase the 37% discrepancy. It’s not an arbitrage situation per se, but, it is a hopeful consideration for CNA shareholders.

CNA’s Revenues and Profitability Soared in 2023

Putting aside Loews vested interest in CNA’s success, the P&C insurer had a strong 2023. Revenues have been on a trajectory higher since 2016 and last year CNA’s revenue growth of 12% continued the trend. Strong client retention, as well as new business and shrewd pricing, have helped sales. The table below shows the longer term revenue picture since the 2009 GFC period.

As for profits, P&C insurers generate their earnings in two connected ways: the underwriting premiums (net of claims and expenses) and the income earned from investing those premiums–the ever important NII. In 2023, both modalities combined to increase CNA’s overall net income by 77%. Validating the thesis that CNA can benefit from higher-for-longer rates, the company increased its NII some 25% in 2023. Net investment income represents the money earned from customers’ premium payments prior to any outflow to settle claims. With short-term rates so high, CNA was able to generate significant income on this so-called “float.” Management expects improved NII to continue, along with the profitable underwriting needed for the float’s size to be enough for vigorous NII. CNA’s underwriting skill is typically measured by the industry’s metric called the “combined ratio.” In simple terms, this conveys how much of the premium is retained by the company after paying claims and other expenses. According to the company’s CFO, last year’s underlying combined ratio was 90.9%, meaning $9.10 of every $100 dollars of premium was retained. Strong NII and profitable underwriting extended CNA’s EPS growth rate of 8.3% since 2019.

Healthy Cash Flow to Cover the Dividend

A company’s cash flow relative to the dividend paid is an important gauge for assessing the dividend’s sustainability and growth potential. As shown in the graphic that follows, CNA ability to cover the dividend with FCF has been healthy.

With a payout ratio around 36%, CNA’s commitment to dividend generation and growth are reasonable expectations. Moreover, the company’s decade-long streak of paying special dividends speaks to ample cash flow, as well as a shareholder friendly management. Recently, another $2.00 special dividend was announced on top of CNA’s regular dividend of 44 cents. In 7 out of the past 10 years, $2.00 has been the amount of the special dividend. The other years averaged ~$1.00 of supplement dividend income. Combing the special dividend and regular payout equates to a 8% yield going forward in 2024.

A Stock Price with 20% Upside Potential

CNA’s stock price relative to its P/E ratio over the past 15 years is shown below. Today, CNA trades at a P/E around 10x earnings. Applying its 15-year average P/E of 13.9x suggests a 40% undervaluation and implies a stock price around $62 per share. Shorter term, CNA’s 5-yr average of 13.3x suggests a stock price of $59/share. The P/E range over these 15 years has seen CNA’s trade as high as 28x earnings and as low as 7x earnings. I agree with Loews management assessment that CNA is undervalued by 20%, implying a 12x P/E and a stock price over $50/share compared to today’s $44 price.

When CNA’s stock dropped to the $36 price level last July (a similar price point seen when March’s banking crisis sunk most financial service stocks), Loews started buying its subsidiary’s stock around the $39/share price point. Today, CNA trades around $44/share, roughly the midpoint between last year’s lows and the conglomerates cited price target of $50/share. On Feb 15th, the stock traded as high as $47/share but has dropped over the past week. The decline in CNA may continue but last year’s lows seem to be a level that attracts buyers (e.g., value investors like Donald Smith and Joel Greenblatt, in addition to Loews). At today’s price of ~$44/share, investors can consider incremental purchases, watching to see if better price points present themselves. Regardless, CNA’s stock should supply income-oriented investors with a growing dividend stream, supplemented by special dividends.

Final Thoughts

Overshadowed by worry over banks and other lenders, the strength of insurers like CNA has been overlooked. Last year’s success can be traced, in part, to higher interest that helped the insurer’s net investment income. With changing interest rate expectations underway in the early months of 2024, CNA’s ability to benefit from higher-for-longer rates continues. This, along with disciplined underwriting, bode well for the P&C insurer fundamentals. Importantly for income investors, CNA has grown its dividend at 7.4% for the past decade, supplementing this regular dividend with special ones. With Loews 92% ownership of the stock, shareholders have a ‘guard dog’ watching over the company, vital to the conglomerate. For the owners of the remaining 8% of outstanding shares, CNA offers investors a growing dividend that yields close to 4%, as well as a low-beta stock with 20% upside potential and limited downside thanks to the protective role Loews can play.