We are initiating coverage of Federated National Holding Company with an Outperform rating. Focused on homeowners’ insurance in Florida, the company is one of the higher-reward/higher-risk opportunities within the insurance segment. Earnings have the potential to increase by 2 to 3 times from 2013 to 2016 and to maintain a much higher-than-average growth profile thereafter. Growth is supported by the company’s ability to take advantage of the continued shift in the $9 billion market in Florida.
The current valuation, 10.2 times our 2015 operating EPS estimate, does not appear to reflect this growth potential. Risks, however, are higher than average. Because of the concentrated nature of the platform, material shifts in Florida’s political landscape or changing dynamics of the reinsurance market could alter Federated National’s growth trajectory. The company should continue to create significant top- and bottom-line growth resulting from a shift in the Florida homeowners’ market from public (i.e., state-run) to private hands.
The market is poised for continued growth and profitability as a result of rate adequacy, low reinsurance costs, and minimal competition from national insurers. After a return to profitability in 2011, the company grew operating EPS by an astounding 175% in 2013. We expect high growth to continue; we forecast EPS growth of 65% in 2014 and an average of 20%- plus EPS growth for 2015 and 2016. Federated National is starting another Floridabased homeowners’ insurer (Monarch) that will allow it to shift its focus from the higher end of the market, where it binds only 12% of submitted quotes, to the lower end and midmarket to provide more coverage options for its agents.
This has the potential to increase operating EPS by roughly 10% to 20% in 2015 and 2016. Forward earnings have significant upside potential compared with our 2014 operating EPS estimate of $2.03. Our upside case projects operating EPS to nearly double from this level through 2016, implying a valuation that is 49% to 82% higher than the current stock price. Our base case projects operating EPS to increase 50% through 2016, implying a valuation that is 11% to 36% higher than the current stock price. We expect return on equity to average close to 19% for 2014 to 2016.