Travelers (TRV -3.14%) is one of the largest property and casualty insurance companies in the U.S. Like most insurers, the Hartford-based company has struggled this year -- its stock price was down about 15% year to date as of Wednesday's close, and earnings fell 25% year over year in the first quarter. Unexpected circumstances have played a role, most notably the COVID-19 pandemic and the resulting economic downturn, which led the Fed to lower its benchmark federal funds rate to 0%.
Investors may be wondering if the stock is still worth holding, or if the company is built to withstand the stresses of these forces. Is Travelers still a buy while it's down?
Recession will hurt insurers
Travelers' stock performance through the first five months of 2020 has roughly been in line with the broader insurance industry, which is down about 17% year to date. The company got hit with $333 million in catastrophic losses, up from $193 million in the previous year's quarter. The losses were due mainly to tornadoes in Tennessee and various winter storms throughout the country.
The COVID-19 pandemic, though, will continue to take a toll going forward. As the country likely moves into recession, the industry will be affected by lower premium levels. "How much and for how long will depend on the extent and duration of the negative economic impacts related to the pandemic," CEO Alan Schnitzer said on the first-quarter earnings call.
This is because property and casualty insurers are sensitive to the trajectory of the gross domestic product, as the need for insurance is often linked to the economy. When it's down, there's less demand, so insurers' performance suffers. Plus, there will likely be an increased number of claims related to COVID-19, and the firm expects additional claim activity related to the increase in furloughs and layoffs of employees through its Employment Practices Liability Insurance (EPLI).
Also, Schnitzer said, surety loss activity for the industry could be higher related to the shutdown and the resulting economic stress. These factors will likely weigh on Travelers' profitability over the next few quarters.
There's also the matter of interest rates, which are at 0% with no expectations to move up for now. This reduces the amount of income insurers make on the company's investments, further hampering earnings.
Is Buffett a Travelers man?
It didn't help that Berkshire Hathaway (BRK.A -1.32%) (BRK.B -1.29%), led by Chairman and CEO Warren Buffett, sold its entire stake in Travelers earlier this year. Buffett had severely lowered his position in the company in December, prior to the pandemic, and then got out entirely in May. So, if the Oracle of Omaha has concerns about the viability of the stock, does that mean you should, too?
Not necessarily. There's no question the company is facing some headwinds that will affect its earnings, but the uncertainty is primarily due to the COVID-19 pandemic and its effects on the economy. Setting the coronavirus aside, Travelers has been one of the steadiest performers in the industry. Through much of the last recession, Travelers posted positive returns, and over the decade that ended last year, it had an annualized return of 10.6%, with only one year in negative territory (although this year's pullback takes that down to 8.7% annualized over the 10-year period ending Wednesday). Also, it's a good sign of stability that the company actually increased its dividend 4% to $0.85 in April -- its 15th straight year of dividend raises. The stock is a solid value, trading at roughly 13 times earnings, and it has a combined ratio of 95.5%, which means it's taking in more in premiums than it's paying out in claims.
Also, Travelers has excellent liquidity to get through the hard times. Its debt-to-capital ratio, or liabilities divided by assets, is 20.6%, which is well within the company's desired 15% to 25% range. This is an important measure of financial strength for insurers in that it gauges the ability to cover debt, which is particularly important in a downturn. A high ratio means the company uses more debt to finance its operations.
"Our balance sheet is extremely strong, our debt-to-capital ratio is comfortably within our target range, our holding company liquidity of $1.6 billion is well above our target level, and we have a very high-quality investment portfolio," Schnitzer said on the first-quarter earnings call. The company generated $519 million in net investment income in the quarter, up 5%.
With a recession looming, Travelers will likely struggle in the near term, and there are certainly better stocks to buy right now. However, if I already owned the stock, I'd hold on to it in an attempt to recapture the gains when things start turning around sometime within the next year. This is one of the major players in the insurance industry, with good fundamentals and a long history of performance. It will come back and should add stability to a portfolio.