Mercury General Retreats Brian Graney (TMF Panic)
November 1, 1999
Auto insurer Mercury General Corp. (NYSE: MCY) lost ground on the insurance battlefront this morning as the company turned in lower-than-expected third-quarter results. Net operating earnings per share fell 19% in the period to $0.59, a much steeper decline than the roughly 5% drop anticipated by analysts. Total premiums written ticked up 4.8%, lower than the 8.7% year-over-year growth seen in Q2. In the crucial California market, where the company does about 90% of its premium writing, premiums written increased by 4.3%.
Observers had been expecting bad news from the company during the quarter, even though Mercury General bucked the trend of other auto insurers and failed to give everyone a heads-up warning with a formal earnings pre-announcement. The sparse comments made by the company in its press release today echoed the primary laments that have become so familiar with property and casualty (P&C) insurance investors lately -- lower pricing and margins due to increasing competition. Additionally, the company noted that rising loss costs due to higher frequency and severity of California automobile claims have only made the profitability situation worse.
Unfortunately, Mercury General can't control what happens when every Californian it insures gets behind the wheel, no more than it can control how many competitors enter its bread-and-butter market. California is the largest auto insurance market in the country, with its roughly $14 billion in annual premiums representing about 11% of the entire U.S. car insurance market. On the national level, Mercury General just barely qualifies as a top 20 private passenger auto insurance premium writer according to rankings by Merrill Lynch and has an estimated national market share of about 1%. However, the company has built a name for itself in California, where it is the number six player and enjoys a 7% market share.
The favorable insurance environment in the Golden State has been good to Mercury General over the years, as the company has used strict cost controls and efficient claims management to produce an average return on equity (ROE) of 20% during each of the past five years. That streak will likely come to an end this year, although the company's annualized ROE at the end of the first half of this year was still a respectable 16%. The growth may be slower than expected right now, but the company is still keeping its head well above water in a tough operating environment industrywide.
The lucrative nature of the California market has attracted competitors, leading to the proliferation of carpet bomb-style advertising campaigns by auto insurers. As a result, acquisition costs have gone up while profit margins have gone down. In the case of Mercury General, the company's combined ratio -- a key measure of profitability in the insurance world -- has moved up to 94.9% for the first nine months of this year. That's up significantly from last year's ratio of 87.6% but still gives the company some breathing room below the 100% level, which represents breakeven performance in the insurance business.
With the auto insurers largely falling out of favor along with the rest of the P&C industry over the past 18 to 24 months, investors may want to use this opportunity to become acquainted with a small but experienced company such as Mercury General. With this morning's drop, the company is trading at 11 times trailing 12-month earnings and roughly 1.5 times its total invested capital. That could end up being a reasonable price for a business that has proven that it knows how to build value and was a 15-bagger during the first seven years of this decade. As the current insurance environment appears to be the only thing holding Mercury General back, the key question for investors is how long the bad times can possibly last.
Mercury General Web site