Allstate: A Non-Grower Priced For Growth (NYSE:ALL)

A friend of mine who is interested in insurance companies asked me to take a look at Allstate (NYSE:ALL) and make my own thesis, so that’s what I’m here to do. Like many big insurance companies, it’s well known for a variety of mascots in its commercials, most recently Mayhem, along with its eminently quotable slogan: “Are you in good hands?”

Customers might very well be in good hands with them. Having looked at this company, though, I don’t think shareholders are, when viewing an in investment in ALL from a long-term, owner’s mindset. As such, I’ll go over what you get with Allstate and why I think, at the current share price, it’s a textbook SELL.

Current Business

The company’s revenues primarily derive from its line of property-liability insurance products, which cover automobile and homeowner’s insurance. It also derives revenue, to a lesser extent, from a variety of other insurance products and insurance-related services.

A slight majority of the company’s assets are their portfolio of investments.

Most of these are investments in fixed-income securities. Those primarily consist of American bonds, most which are corporate issues, with a lesser amount in federal/municipal issues. A somewhat sizable portion are in limited-partnership interests. In their 2022 Form 10K (pg. 125), the company describes these represent partial ownership in private equity funds and real estate.

Looking at the different segments, most of the revenues come from the Allstate proper. A majority of premiums come from automobile insurance.

Taken as a whole, the combined ratio of the company indicates that Allstate does not generate an underwriting profit. Some of this is due to the impact of severe storms for their homeowner products, but we also see that even their automobile products are unprofitable. This will be something that the company needs to address going forward.

Financial History

Over the past decade, some of these numbers indicate a growing company, but others do not. Let’s review what exactly Allstate accomplished in that time. This will include reported YTD date for 2023. Folks should remember that FY results will be released in a few weeks.

Revenues did grow over the decade but slowly. From 2014 – 2022, it was a CAGR of 4.29%.

The trajectory of net income was different. It was steadily leaning toward growth, suddenly falling into the negatives for 2022 and 2023. Since revenues haven’t moved too much, the main two things that management cites in its 10Ks as causing the rise and fall of net income has been the amount of losses from claims from their policies and if the investment portfolio had any realized gains or losses that year. I’ll quote their 2019 Form 10K (pg. 35):

Consolidated net income applicable to common shareholders increased $2.67 billion in 2019 compared to 2018, primarily due to net realized capital gains in 2019 compared to losses in 2018 from increased valuations on equity investments and higher underwriting income in Allstate Protection.

For the last two years in particular, claims and realized losses have been high enough to push net income negative.

In 2021, we can see that the balance sheet shrank substantially. Some of this was due to the disposition and sales of the Allstate Life Insurance Company and the Allstate Life Insurance Company of New York. As CEO Tom Wilson explained:

Allstate is deploying capital out of lower growth and return businesses while continuing to execute our strategy to grow market share in personal property-liability and expand protection solutions for customers.

In their 10K, they noted (pg. 114) that the sale was for about $4.4b, but they recorded a loss of $4b on it. Given these remarks and the underwriting losses they’ve sustained since then, it doesn’t appear that this was well-timed.

Consequently, tangible book value for the company is at decade-long low. Crucially, the TBV per share is down from $46.27 in 2014 to $34.69 as of Q3 2023, and there’s more to this than just selling off assets and incurring losses.

Pulling the cash flow data shows us that a substantial portion of earnings have been spent on share buybacks over the last decade. Were these done at a good price?

A history of the Price/Book ratio shows that shares of ALL have almost always traded at a premium to book, often a substantial one at that. Amazingly, in spite of the losses and poor financial results, the P/B climbed over 2 and even 3, with share repurchases continuing. I find this to be a puzzling destruction of long-term shareholder equity, which is stranger considering Wilson’s emphasis on returns regarding the disposition of Allstate’s life insurance businesses.

A Look to the Future

With everything I have said so far, we need to look at how the company is attempting to reverse course.

Further Dispositions

Allstate is next looking to sell its Health and Benefits business, which it expects to complete this year. In the Q3 2023 earnings call, Wilson explained:

So — we’re selling the businesses because it’s the best way to capture the value credit. They’re terrific businesses. I mean we make almost a quarter-billion a year. And we get a good platform, they have low capital requirements. We like the businesses. When we look forward to the future, though, we said we think we can harvest more growth from it if we had more complementary distribution, a broader set of products, capabilities such as network management of a health network to manage that. Those are things that we don’t have today.

We said we can build those. It would take us time and money. On the other hand, we could access those that already exist. But that requires us to let go of the success we’ve created. So we decided to choose the latter path.

One has to wonder why such glowing praise makes a sale so tempting. It will ultimately depend on what kind of price Allstate gets and then what they do with those proceeds, but considering the shrinkage of the balance sheet we’ve already seen, this strategy isn’t immediately assuring to me.

Pivoting to Profits

Allstate is currently implementing efforts to shift to profitability with its main automobile product, which is largely about increasing volume at lower average cost. As Wilson explained in the same earnings call:

Let me — so first, the transformative growth is about increasing market share in personal profit liability. It’s got a couple of components at the core of that is being low-cost insurance but also about raising customer value and also about being available to people however they want to get to a specter segment and the customers. So I would say at this point, we’ve proven that the underlying assumptions that we had made going into it work. So we know that lower price raises close rate. We know that’s true. We know that being available through more people, whether that’s through different bundling with exclusive agents through independent agents or direct also works and we can do that.

This is also a matter of exiting states whose insurance environments have been a huge drain on cash for Allstate

California, New York, and New Jersey have been loss-heavy, and they have reduced new policies there significantly in the course of 2023. I believe there will be visible improvement in earnings for 2024 because of this. As Mario Rizzo (President of Property-Liability) also explained in the earnings call:

We’ve got 3 significant rates pending rate pending across all 3 states. We have an auto rate in California that we filed back in May, I believe, 35% we’ve got a 29% filing pending in New Jersey. We implemented rates in New York ranging from high single digits to low double digits or low teens across our opening closed books middle of the year. We just filed for another 18.3% in New York auto.

So we’ve got significant rates pending with the department. As Tom mentioned, where we’re at now is we need action those filings in the fourth quarter. And if we can’t, then we believe the right thing to do for the customers in the other 47 states as well as for our shareholders is to take additional action to get smaller across all 3 of those states and that’s what we would do beginning next year if we can’t get resolution on the rate filings that are currently pending.

So their ability to raise rates is limited by procedure, and they’re winding down sales until the prices work for them better. Once again, even if the rate increases don’t happen in the timeframe they want, avoiding risky new sales is easy enough to do.

Still much of this successful turnaround depends on growing and thus capturing market share. As ValuePenguin shows, they already have quite a bit, over 10%, and the top ten control 77% of the U.S. market.

Yet, Allstate hasn’t moved much in gaining market share over the years. It was surpassed by Progressive (PGR) in 2018, which then took a bigger lead by today. When I recently covered Progressive, the main source of their losses has been their exposure to homeowner’s products in storm-prone states like Florida. Their Auto Line is profitable.

The competitive environment really makes this tough too. In this slide I excerpted, they point out that GEICO (subsidiary under BRK.A) and Progressive are profitable contenders in this space. It’s worth noting that they talked about profit over the decade, not over the last two years, where Allstate’s risk models clearly weren’t pricing accurately.

My point is that there are some levers they can pull, but I believe that the kind of growth they want, against competitors who have clearly executed better over the years, is not likely to occur.

Buybacks

Since we’re buying individual shares, the realities to the entire enterprise aren’t the only things to consider. We also have to think about what the impact is to the value of shares themselves.

In spite of the P/B around 2 throughout 2023 and the negative earnings, the company spent over $2 billion on share buybacks in the first nine months. Considering this has been typical over the decade, I believe it is likely to continue into the future.

This is just burning cash with a bad return on capital, especially since the P/B is now over 3. They have been selling off pieces of the business to source extra capital, while these buybacks that are completely optional.

Buybacks, of course, can push the stock price up in the short term, and that might partly explain why the shares are at an all-time-high. Yet, I am looking at this from a long-term point of view. Would I feel good about these capital-depletive buybacks while holding over a decade? No.

Valuation

Considering that this business isn’t currently profitable and doesn’t seem likely to grow much when it does generate earnings, the only fair valuation, in my eyes, is to low-ball it.

I’m sticking to tangible book value per share, which was last determined to be $34.69. Now, that should be recalculated once FY 2023 results are out with an updated balance sheet. At $154.11, ALL currently trades well in excess of TBV and probably what the soon-to-be updated TBV is. Considering how future losses and the effects of buybacks can reduce that further, I don’t think it would be a practical buy unless it was at a significant discount to TBV.

Yet, there’s more to say about it than just that. Why is it currently so high? Well, I mentioned the buybacks as a possible, short-term force keeping it up, but there is something else.

If we look at the total returns of ALL and S&P Insurance Select Industry Index, we can see that both outperformed the S&P 500 since the beginning of 2022, which saw the onset of the War in Ukraine and interest rate hikes. This was more pronounced in the earlier part of this period, mostly likely because the market often sees big insurers as “defensive stocks” in case of a recession. If people get scared of other stocks and do this, this means they’re willing to pay more for insurance, and share prices go up.

Neither of these have anything to do with the fundamentals of the individual insurance business. Some insurance businesses might have earned this premium, but not all have. It’s a matter of when reality finally catches up.

Conclusion

Allstate is a major player in the automobile insurance market and other spaces, but it hasn’t competed as successfully as some of its bigger rivals. Recent financial results have shown that policies have been underwritten poorly for the risk involved. Buybacks are done even when there are no earnings and without apparent regard for the shareholder returns from those buybacks. Instead, profitable business lines are being shed in order to source capital that could have come from eliminating the buybacks.

I think management has shown a long record of not acting in the interest of shareholder value. Consequently, even if they get back to an underwriting profit with reasonable growth, I don’t think people holding ALL are likely to realize it. The current share price seems more like a bubble that this asking to be burst, and so anyone holding today that’s ridden the stock to this all-time-high would, in my view, be better served by selling.