DEFINITY FINANCIAL CORP.
Personal Auto Is Shifting To A Positive Earnings Driver
Our Conclusion
Conviction in our Outperformer thesis increases following Q2 results.
Personal auto should now be thought of as a potential source of earnings
upside, not downside. Investment income remains a source of earnings
upside with higher bond yields. Personal property and commercial lines are
performing to expectations and excess capital remains a catalyst. Our EPS
estimates have increased ~3%. Our price target increases by a like amount,
from $39.50 to $40.50. DFY offers strong earnings momentum, deployment
of capital as a catalyst, reasonable valuation, and defensive characteristics in
a tough macro backdrop.
Key Points
Positive EPS revisions: We are revising our 2023E and 2024E EPS by
roughly 3% for each year. The primary drivers for 2023E are the Q2 beat and
higher investment income. For 2024E, we have also revised our investment
income forecast higher, and forecast somewhat higher personal auto
underwriting income (i.e., lower combined ratio).
Investment income remains a positive earnings catalyst: Q2 investment
income was up 35% Y/Y and 7% higher than our forecast. Management now
expects investment income to exceed $160MM in 2023 (prior guide was
$160MM). We are forecasting $165MM in 2023 and $170MM in 2024 as
current bond yields imply further upside.
Personal auto should be thought of as a source of potential upside: Q2
personal auto results were solid and premium rate momentum suggests an
increasingly positive narrative. Earned rates were up 5.5% in Q2, are
expected to hit 8.5% by end of 2023, and then increase by double digits in
2024. We assume a combined ratio of 98.4% in 2023 and 97.3% in 2024 due
to the benefit of rates outstripping claims inflation. Every one point
improvement in the personal auto combined ratio lifts 2024E EPS by ~4%.
No negative surprise on personal property: We do not think the outlook
for personal property has changed despite the perception that weather-
related events have become more problematic. Premium rate increases plus
loss mitigation actions have been effective at protecting margins over time
and that continues to be the case. We assume a combined ratio of 96% this
year and 95% next year, consistent with DFY’s expectation for mid-90s.
Commercial lines remain a great growth story: Q2 direct premiums
written were up 15% Y/Y and the combined ratio, excluding prior year
development, was a solid 90%. We expect double-digit growth can continue
through 2024 (11%) and forecast a 2024 combined ratio of 91%.
Deployment of excess capital boosts EPS and ROE: DFY has >$200MM
of excess capital pro forma the Drayden acquisition and nearly $1.3B of
leverage capacity once conversion to a CBCA is approved. We estimate that
ROE should reach ~12% with full capital deployment.