Cincinnati Financial: Some Upside Realized, More Possible (CINF)

Dear readers/followers,

Revisiting Cincinnati Financial (NASDAQ:CINF) after my last article is a pleasant exercise because the investment has outperformed the market by close to 18%. The company is a P&C insurer with an august history – my second article on the company will focus on the recent set of results for the business, and how we should be playing this opportunity in this market.

Take a look at how things have performed since my first article, and since I bought shares of the company’s common.

Now, that is obviously a good RoR and the time has come to revisit the upside here.

Cincinnati Financial – Revisiting the business

CINF is an insurance business – and it works primarily with life, disability, and P&C. The company operates through various subsidiaries across the nation. Now, the P&C business is an incredibly fragmented market – by far one of the more fragmented markets out there when comparing to things like healthcare insurance or the like.

The company has a 1% market share of US P&C, and this single percentage point makes CINF one of the 20th largest insurance businesses by market share in the US. The company has a solid history going back around 70 years and works with thousands of agency relationships across the nation in over 2,750 locations. Its biggest market share is obviously in Ohio, but CINF is represented in plenty of areas.

The company is commercial-heavy as opposed to personal. It’s agency-focused – meaning local decision-making is based on local expertise, with a centralized organization at the same time contributing to a low expense ratio compared to a branch office structure.

CINF is one of the best financial companies on record if we look strictly at the dividend growth tradition. The company has offered 61 years of consecutive increases in the dividend, making this one of the strongest dividend kings out there, and only seven public US companies can match this dividend payout record.

The company has been an impressive grower of dividends as well either, with a double-digit sort of growth history. Last time I wrote about the company, we had almost 3% – now that’s down to around 2.6%.

Now, insurance usually yields a lot more. The reason this one doesn’t is obviously the dividend king tradition of over 60 years of growth. There are plenty of reasons you want to be investing in insurance and in finance in the environment we’re currently in, but you should make sure that when you do, some of the basics are fulfilled.

You want to make sure of a few things. First, you want to make sure that the company has the ability, based on historical and forecasts, to outperform the market-average premium growth rate over time. CINF does this. Its 7%+ premium growth rate on an annual base for 5 years is higher than the industry average of around 5.9%.

Combined ratio development has been solid as well – and for a US insurer, the sub-90% combined ratio on average over the past few years is enough to really get me interested here.

The latest results are as follows – and pay attention here, because it’s an illustrative quarter as far as P&C companies go.

Cincinnati Financial had an impacted quarter. The company’s losses from Hurricane Ian pushed the company’s quarterly combined ratio to over 100% – 103.9% to be exact, and the focus wasn’t on this, but on servicing claims coming in during that quarter. However, despite that quarter and Hurricane Ian, the company’s insurance operations remain profitable for YTD22, with a combined ratio of 99.2%, and a year-end goal in the 95-100% range.

These combined ratios really bear watching, because they tell the story of the company’s underlying operations.

That isn’t to say that there aren’t real challenges though. The combination of inflation, macro, and severe weather is a sort of perfect storm for the company’s bottom line, which is expected to materialize in a massive ~33% adjusted EPS drop for 2022 before slow recovery will bring it back up to 2023-2024E.

I view this pattern as very realistic given the earnings flow we’ve seen over the past few quarters – and remember, the company has an investment portfolio that delivers safety and returns in a way that precludes the company from any real foundational issues. The company saw an 8% increase in its 3Q22 YoY EBIT for the investment portfolio of the business, and CINF held a $3.8B liquidity in its parent company in terms of cash and marketable securities. This is down for the year, but plenty of cash to cover any current or near-term shortfall.

The bullish case for CINF hinges on believing that the company is able to continue to deliver good returns. This includes handling inflation – which traditionally, CINF and other insurers do through expertly-calculated pricing models. Here’s a small insight in what the company does in terms of this.

When considering new or renewal business, our underwriters are focused on risk selection and pricing discipline. Our continued strong net written premium growth of 14% on both a quarterly and nine-month basis reflects our management of both exposure growth and net rate increases that factor in expected inflation effects. Premium growth also benefits from 162 new agency appointments so far this year and our efforts to gain a larger share of each agency’s business.

(Source: CINF 3Q22 Results comments)

The company’s current situation means that CINF has to include in its calculation the costs of inflation across the board for things like building materials when calculating P&C coverage. CINF does use inflation factors for its policy renewals, so the housing/building is easier, but CINF has already communicated that the auto lines are going to see rate increases across the entire board. Inflation levels for insurance haven’t seen this sort of increase in decades, and the effects will be felt for years as things seem now.

Obviously, CINF is far from the only shop seeing these trends, and we should expect other companies in the field, especially in P&C, to start reporting and increasing their pricing as well. I’m keeping a close eye on companies both on the EU and NA side of the pond to see how numbers are coming in for peers of CINF and other insurance companies in other sub-sectors.

CINF fundamentals remain solid – and that’s where the company shines. We combine this with valuation, and there is a scenario where an upside is possible despite an 11% climb in a few months, contrary to the market.

Cincinnati Financial Valuation

In my original article on CINF, the company’s valuation was pretty damn good, if we look at historical premiums – and when looking at a dividend king, I think a premium is a good thing to allow. This company’s average is close to 24x for the past 5 years P/E, and the current average weighted valuation is around 23x P/E.

Compared to where the company was in my last article, that means that almost all of the premium here is pretty much “caught up”. 11% RoR means that there’s not much upside to my near-term PT left.

The company is expected to make good results in the coming two years. If accepting a 24x P/E premium, this would imply a double-digit 20.79% total potential RoR, which again is pretty damn good. But I won’t pay 24-25x P/E in an environment where quality insurance trades down in single digits.

It no longer makes sense. I gave the company a PT of $105/share in my last article. This was a profitable price target. The company is technically still below that, and despite the earnings crash for the full year we haven’t seen any sort of massive deterioration, which leads me to believe that it probably won’t happen early next year before the end-year report either.

So, I won’t change my PT – but I won’t increase it either. There’s too much of a premium here for me to be comfortable raising it further, even with the company’s quality as it is.

The key to investing in CINF is valuation. While the company does perform very well over time, it’s not the sort of company to massively outperform the S&P500 index. What this means is that you can’t buy this company at any price and expect to do well.

You might not think of this as overly exciting, but let me remind you that this is the top-8 dividend king on the entire US stock market. It might still be worth it on that basis, for you.

S&P Global has 5 analysts following the company – only one has a “BUY” rating here. The analysts have been lowering their PTs for over a year now, from around $140 down to an average of current $108.60, from a range of $98 to $130/share. I believe these targets to mostly be fair, but I would still cut it down a few more dollars to $105/share.

Here is my overall thesis and target for CINF as they currently stand.

Thesis for Cincinnati Financial’s Common Shares

• This is a conservative, appealing insurance company and one of the market leaders in insurance in the USA. The company has some of the most qualitative portfolios and track records out there, being a dividend king with more than 60 years’ worth of dividend increases under its belt.
• At the right valuation, this company becomes a “must-buy”. Even at today’s valuation, CINF has a decent overall upside to a conservative valuation based on average historical valuations.
• Based on this, I consider CINF to be a “Buy” here. But the valuation dictates that the upside is no higher than 2% here.

Remember, I’m all about :

1. Buying undervalued – even if that undervaluation is slight, and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn’t go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them. (italicized)

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

The Options Play for Cincinnati Financial

We’ll also work with Cincinnati Financial as an options play. The current valuation and trading preclude any truly massive annualized rates of return, especially with the company being a dividend king, but we can eke out some gains that are superior to the company’s currently meager dividends while ensuring a lower buy-in price.

Here is one such possibility I found that I myself am considering at market bell if the premiums stay at similar levels. The near-term options for January and February offer too small returns – but we can get double digits from the March puts.

It’s a hefty capital outlay, but it’s a safe yield, and you’d be buying a dividend king well below par, where it yields nearly 3%, and at a cost basis that’s extremely attractive, all things considered. The only drawbacks of this put is that it’s nearly 3 months forward, and the over $9000 exposure. Other than that, it’s a solid play that one could go for.