CinFin Upgraded to Neutral - Analyst Blog

We are upgrading our recommendation on Cincinnati Financial Corp. (CINF) to Neutral on the back of potential top-line growth from new business and strong retention in its Personal Lines segment which has been underperforming for the past three years. However, with an improvement in new business levels and strong retention levels along with rate increases that affected the homeowner line in 2009, it will bring a moderate growth in 2010.
 
Cincinnati’s second quarter earnings beat the Zacks Consensus Estimate on an increase in investment income coupled with a decline in underwriting loss.
 
Given Cincinnati’s agent-centric business model, its relationship with local insurance agencies is a primary strategic advantage. During 2008 and 2009, the company appointed 76 and 87 agencies, respectively, and aims to appoint 65 agencies in 2010. Its technological projects improve critical efficiencies and streamline processes for the agencies, allowing it to gain an increasing market share.
 
Cincinnati is working on growing premiums through geographical diversification. Since 2007, it has entered five new states − New Mexico, Washington, Texas, Colorado and Wyoming. In the second half of this year, it plans to enter Connecticut and Oregon. The growth initiatives in the new states are part of a positioning strategy for long-term growth.
 
However, Cincinnati’s Commercial Lines segment, which accounted for 75% of 2009 net written premiums, is still experiencing strong competition in the market, making it difficult to increase prices. This trend is expected to continue until the fragile economy strengthens significantly.
 
Investment income is an important component of Cincinnati Financial’s revenues and net income. The company has experienced investment portfolio problems as a result of equity investments that formed a significant portion of its portfolio prior to mid-2008. Though the business has been diversified to reduce equity concentration and is only 25% of the total portfolio currently, it is still equity-heavy relative to its peers. We do not expect significant gains till the equity markets recover completely. Moreover, low yields for investment options could continue, limiting investment income growth.
 
But we note that Cincinnati’s reliance on debt as a source of capital has been low. It targets a debt-to-total-capital ratio of less than 20%. At year-end 2009, this ratio was 15.0% compared with 16.7% at year-end 2008 and 12.7% at year-end 2007. Moreover, its premium-to-surplus ratio has been favorable, with a year-end 2009 ratio of 0.8:1, compared with 0.9:1 in 2008 and 0.7:1 in 2007. The premium-to-surplus ratio is a common measure of operating leverage used in the property casualty industry; the lower the ratio, the greater the company’s capacity for premium growth.
 
Moreover, Cincinnati’s consistent cash flows and prudent cash balances continue to create strong liquidity. A robust capital position would precipitate premium growth, besides providing the liquidity to pay claims along with making sustainable investment for other strategic initiatives.