Erie Indemnity: Booming, but share price not yet worthy (NASDAQ: ERIE)

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AlexanderFord

Erie Compensation Society (NASDAQ:ERIE) remains robust with solid fundamentals. It is well positioned, given its highly strategic pricing and strong customer base. Its stellar balance sheet proves its ability to sustain its size and cover its borrowings and dividends. Now that P&C insurance is at the forefront of climate change, growth prospects are more attractive. Even better, the share price no longer appears disconnected from its fundamentals.

Business performance

With nearly a century of existence in Erie, Pennsylvania, Erie Indemnity Company acts as attorney-of-fact for the Erie Insurance Exchange, owned by policyholders and subscribers. It engages in property and casualty insurance, providing policy underwriting, renewal and issuance services for policyholders. Thus, its main source of income consists of management fees related to the issuance and renewal of policies, as well as reimbursements.

ERIE and Erie Insurance Exchange are mutually dependent. They ensure the fundamental solidity of each other. Their strong link lies with the policyholders or underwriters. As such, ERIE imposes management fees on a portion of the premiums issued. The rate of management fees varies according to the current and projected financial statements of the Exchange. In accordance with the policyholder’s contract, the maximum management fee for premiums issued is 25%. Simply put, the success of its insurance companies on the Stock Exchange is also the success of ERIE. The increase in fonts written and retained results in more returns for ERIE.

To understand it better, the primary function of ERIE is to execute and manage business operations. Erie Indemnity Co. operates a very unique business model. This is because the exchange has no employees or agents. Thus, it provides other services, including customer and administrative support, IT, sales and advertising, and agent compensation. It is classified as an insurance company, but it acts more like an insurance service provider. It may be quite unconventional, but this pattern leads to a more stable level of viability.

Today, insurance data is geared towards the continued flourishing of insurance businesses on the stock exchange. In fact, there is an increase in retention of policyholders and subscribers. This is most evident in the exchange of health insurance with a Booming CAGR. He is mainly driven by pandemic fears. I think P&C insurance is following the same trend as it is also at the forefront of climate change resilience. The same uptrend is visible in Erie Indemnity Company.

In ERIE, the policies in force are 3.1% higher than in Q1 2021. This is a combination of increased new premiums and policy retention. Policy retention rate increased by 0.9%. This is much better than in 1Q 2021 with a decrease of 8% compared to 1Q 2020. Likewise, new premiums are 4% higher than in 1Q 2021 and 20% higher than in 1Q 2020. Its business and personal lines show upward momentum. It’s a nice trend since policy issuance and renewal are its main drivers of revenue growth.

ERIE’s operating income, including investment income, is $669 million. This is a 6% year-over-year growth compared to the comparative quarter. Again, it is fed by its main stream of income, the management fees related to the issuance and renewal of policies. Its administrative services reimbursement income is also higher than the previous year. Indeed, its popularity in Pennsylvania and the boom in the underlying insurance business are behind its success.

Operating revenue

Revenues (MarketWatch)

But, ERIE does not only depend on external factors. It has significant operational capacity and capital, enabling it to sustain its operations and its innovation. Note that even the insurance industry is also technology driven amid digital transformation. Additionally, its insurance business has strategic pricing, lower than many of its peers in Pennsylvania. The average annual premium for his home insurance is only $774. NerdWallet gives it 4.5 stars, making it one of the top five insurance service providers in the state. The premium is also lower than the state and national average of $930 and $1,784, respectively. Similarly, his automobile insurance of $1,288 is well below the state and national average of $2,002 and $1,771. As such, it is more flexible, which is more vital amid inflationary pressures and increased demand for P&C insurance. There is still more room to adjust prices to generate more rewards and offset increased expenses. With more premiums, more services are required from ERIE, and therefore more management and administration costs.

Home and auto insurance rates

Home insurance and car insurance rates (NerdWallet and Bankrate)

Even better, ERIE keeps its management efficient. There are no economies of scale since the increase in income is also the same as the increase in expenses. Yet the fact that he keeps his costs and expenses manageable means a lot to the business. Operations are more stable compared to the 3rd and 4th quarters of 2021. It should be noted that the impact of Hurricane Ida led to an upsurge in claims and insurance demand. It adheres to the industry trend that an exchange’s underlying insurance businesses achieve more stable revenue. The operating margin is 0.125 against 0.12 in the comparative quarter.

Operating margin

Operating margin (MarketWatch)

Why Erie Indemnity Company can stay afloat despite economic uncertainties

The recovery of the US economy does not seem as simple as initially expected. The increase in production and expenditure causes prices to soar. Thus, the recent inflation rate set a new all-time high at 9.1%. This is most evident in the real estate market, given the skyrocketing demand and shortage. Today, the average home price is over $400,000. It’s no wonder the housing market appeared to cool with a 3% drop in incomes. In contrast, inflation increases the value of the house, parts of the house, and possessions. Thus, the demand for P&C insurance could be supported. We must also take into account the increased frequency and intensity of natural disasters in recent years. Hurricane Ida is a perfect example, causing $2.5 billion to $3.5 billion in damage in Pennsylvania. Additionally, demand for homes is still above pre-pandemic levels, with millennials making up the majority. This is why P&C insurance is at the forefront of climate resilience and could grow by 3.3-3.7% between 2022 and 2024.

Expansion of the home insurance market

Expansion of the home insurance market (Insurance Journal)

Likewise, the auto insurance industry is seeing a shortage of new and old cars. But its value is still high as more and more people still prefer to drive private cars. Earlier this year, 80% of Americans expressed a preference for passenger cars when commuting to work and other establishments. It also adheres to the 7% increase in car sales in the 1st quarter of 2022. Auto insurance could benefit from its fallout. RVs are still on an uptrend despite rising fuel prices. Pent-up demand for leisure travel is the main driver of growth.

Given this, the industry’s performance could remain robust in the coming years. These could lead to a sustained increase in its personal and business lines. Moreover, it could improve its car insurance segment, an important factor that affects its profitability. It’s still possible, given its impressive retention and renewal policy. It can expand to take advantage of the potential boom. It is on the right track as it continues to capitalize on innovation and technology.

Erie has more attractive growth prospects, given the potential increase in the industry. Also, it has a strong market positioning with its strategic pricing and customer base. Yet its strong financial position is what makes it strong and enduring. Its cash and cash equivalents alone are sufficient to cover its borrowings. If we add all his investment securities, they will represent approximately 50% of the total assets. Its investment securities are also conservative, which can produce more long-term returns. This can be a challenge now, given rising interest rates. But their appeal appears to be bouncing back as recession fears return. Overall, his record is stellar.

Cash and cash equivalents and borrowings

Cash and cash equivalents and borrowings (MarketWatch)

Stock price valuation

The stock price has been in a strong uptrend for two months. After its drop from 4Q 2021 to April 2022, it bounced back into its range in December. To $191.38, the share price is only 1% higher than the starting price. The PE ratio of 34.24 is well above the ideal and historical earnings multiple. Other valuation ratios like EV/EBITDA of 23.84 also show that the price is high.

Meanwhile, dividend payments are high and uninterrupted. With a dividend yield of 2.33%, it is well above the S&P 500 and NASDAQ components with 1.69% and 1.51%, respectively. For its consistent dividend payouts for over thirty years, it is one of the Dividend Champions. This year, quarterly payouts are $1.11 per share, up 7% from the previous year. They are still well hedged with a dividend payout ratio of 85%. We can better assess the price using the DCF model and the dividend payout ratio

DCF model

FCFF $244,000,000

Cash $141,000

Outstanding loans $900,000

Growth rate to infinity 4.8%

WACC 9%

Common shares outstanding 52,290,000

Share price $191.38

Derived value $172.24

Dividend discount model

Share price $191.38

Average dividend growth 0.1077366104

Estimated dividend per share $4.44

Cost of capital Equity 0.1339365268

Derived value $169.7239025 or $169.72

Both models adhere to the potential overvaluation of the company. There may be an 11-15% drop. So, this does not represent an ideal buying opportunity at this time.

Conclusion

Erie Indemnity Company is already a strong and well-positioned company. Its fundamentals are well suited to a difficult market and also present interesting growth prospects. Dividends are also attractive and sustainable. But the stock price is not at an ideal level of $168-172. Valuations show that now is not a good time to buy stocks. Still, I’m confident in his performance. Thus, investors still have to wait for a better entry point. The recommendation is that Erie Indemnity Company is a holdback.

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