When I look at Chubb (NYSE: CB), I can see plenty of reasons why it could be a great investment. In their search for flashy growth, investors easily forget the point investments and the primary goal of any business. The primary goal of any business is to increase shareholder value, and I’ve seen this reflected more in Chubb than in many other stocks for some time now. What factors allow Chubb to achieve this?
- Diversified business
- Strong financial performance
- Strong position (market and profitability)
In my text, I will expand on each of these factors and also offer insight into how they can provide less correlated returns relative to the index, which is important if you have concentrated exposure to the market.
Diversified business model
Chubb is a a global insurance company (the world’s largest publicly traded insurance company) that provides a wide range of insurance products and services to individuals, families and businesses around the world. For individuals and families, their wide range of products covers Home, Automotive, Valuables, Boats & Yachts, Cyber, Liability, Travel, Natural Disasters and Bespoke Services. Business insurance covers a wide range of services with categories ranging from accident and health insurance to workplace benefits.
This diversification is even more evident when looking at how premiums are distributed across segments. With multiple different segments accounting for at least $1 billion in written premiums, the business is estimated to generate more than 40% of its premiums outside of its core US market by 2022. Over the past ten years, its consumer-commercial split has also improved from being 28% of their premiums on 37% of their premiums.
Strong financial performance
Let’s look at its performance in Q3 YTD 2022 and compare it to the same time period in 2019.
- Gross written premiums amount to USD 39.6 billion, an increase of 31%
- P&C insurance revenue was $3.4 billion, up 56%
- Core operating income was $4.8 billion, an increase of 32% over 2019
- Core operating earnings per share at $11.2, up 43%
- Operating cash flow of $8.6 billion, up 75%
Chubb has had one major acquisition in the last five years (Cigna) that has contributed to the growth of its business. There is a belief that Chubb can maintain its growth momentum. As part of its long-term growth strategy, it is expanding its presence in Asia by increasing its ownership stake in Huatai. His vision is significant growth and improvement of Huatai’s profitability in the next 5 years, and the big opportunity lies in the Chinese insurance market itself, which is considered to be at an early stage and underdeveloped. With a strong balance sheet, an investor can have confidence in their ability to execute on their long-term vision.
- Its debt-to-asset ratio has always been below 10% and currently stands at 7.83%
- Debt ($14-15B) and interest on debt ($1.4B) compares well with cash flow from operations and EBIT (LTM – $7B)
Chubb is third in specialty underwriters, first in high net worth insurance, first in multi-peril crop insurance and has a greater than 90% retention rate in most of these categories in North America. Also, the North American market alone is expected to bring in around USD 33 billion in gross written premiums.
Abroad, it provides general insurance in about 51 countries and is expected to bring in 13 billion dollars in gross written premiums for the entire year. Although it is not the market leader in any category here, it has shown significant growth in retail in Europe (↑ 47%), wholesale in London (↑ 75%), Latin America (↑ 21%) and the Asia Pacific and Far East region ( ↑ 35%) from 2019.
Zooming specifically into Asia, it is spread across 15 countries, has 200 offices and 75k agents with very few brokers having comparable depth in Asia. With 40% of global GDP but only 26% of the global insurance market, the company sees a huge opportunity for growth here and as such will look to deepen its presence in Asia by increasing its ownership in Huatai to 82%. Regulatory approval is expected to be completed in the first quarter of 2023. As of 2021, Huatai generates approximately US$2 billion in revenue and has assets in excess of US$10 billion.
Combined ratios and expense ratios are parameters used to measure profitability in the insurance industry. While the combined ratio compares incurred losses and expenses to the premium earned, the expense ratio compares only the expenses (acquisition, insurance, etc.) to the net premiums earned by the company. In both cases, Chubb is better positioned than its peers and has been outperforming its competitors for a long time.
Nature of return
When I look at Chubb’s price action, it is very apparent that it is giving a return that is less correlated to the overall market. It has a Beta value of 0.7 (the lower the beta, the less it is affected by market movements). I believe that the nature of the industry (insurance) that Chubb operates in contributes greatly to the nature of its returns. Looking at price action over the past five years, Chubb has returned 73% compared to SPY’s 57%. Most of this outperformance came last year (18% vs -13%) underscoring our contention that returns could be more stable and stable than the overall market. This is important if your portfolio has concentrated exposure that is easily affected by market movements. In a rising market, returns from a high-beta portfolio can easily be mistaken or attributed to one’s ingenuity, but a punishing market will seriously threaten the same portfolio. Therefore, it is important to have a balanced portfolio, and Chubb can potentially play a good role in bringing balance to such portfolios.
Is this a good time to enter?
Chubb is a mature company with stable and predictable cash flow. Its cash flows are also less likely to be affected by changes in the wider economy. Let’s try to answer this question using discounted cash flow analysis with leverage.
Step I – Cash flow forecast for the next five years, I used a growth rate of 5% revenue increase from 2023 and a cash flow margin of 20% (much less than the average of the last five years)
Step II – The next step is to find the weighted average cost of capital. We set a value of 3.5% for our risk-free rate (the current yield on the 10-year Treasury). The market risk premium is 3.8%, which gives us (WACC) 5.64%.
Step III – Plugging this number (WACC) into our free cash flow increment gives us a total present value of leveraged free cash flow of $4.7 billion
Step IV – Calculation of the terminal value using the perpetual growth method with a long-term growth rate of 2% gives the present value of the terminal value.
Step V – In the last step, we calculate the intrinsic value and compare it with the current market price. The gap (>50%) we observe shows us that this section is underestimated and there is a very strong case for buying at those levels.
It should be understood that DCF analysis can become subjective and that various factors can affect this estimate. The assumption of slower revenue growth or lower operating cash flow (OCF margin) may reduce our intrinsic value. Lower operating cash flow can be the result of a low IRR project or a bad acquisition. Another important factor is the market risk premium. A higher market risk premium as a result of lower yields or higher returns in the stock market could play a large role in lowering our intrinsic valuation.
From my experiments, I found that when I moved the OCF margin to <14% and also revised the market risk premium by 2 - 3%, the intrinsic value started to become comparable to the current share price level. However, such a scenario seems extremely rare and difficult to justify at this point, so I'll stick with my previous analysis.
Chubb has done a tremendous job of addressing the typical risks an insurance company faces. The last two decades have been quite eventful, but Chubb has weathered those events well and managed to increase its book value per share over the years.
The only outstanding risk that would be unique to Chubb and also unprecedented in its history as a public company would be the company’s increased exposure to China. Initially seen as a growth opportunity, sentiment is slowly turning away from investing in China, and the company acknowledges this as a source of risk. At a time when companies are reducing their exposure to China, her decision to increase exposure could prove ill-advised. In the worst case, the company could be forced to write off this investment.
I will start a small position in the company. If this stock experiences a significant decline, I will examine whether there is another opportunity to increase my position. In any case, the total position would not exceed 5% of my portfolio.