Description

Kingstone Companies Inc. (ticker: KINS) is a $62 million market cap homeowner insurer in the state of New York. The stock trades about 15,000 shares per day at $8.40/share. The business is worth $10 to $12 per share based on 10-12x P/E and 1.5-2.0x P/BV, offering a 30% return over the next 12 months. Plus the business may be able to compound value at 15-20% annually, offering strong multi-year returns. Kingstone has a motivated management team that is aligned with shareholders, a strong business mix, a strong track record of disciplined underwriting and market share growth with a smart growth strategy going forward, a more consistent earnings stream from increased use of reinsurance, and an attractive valuation.

Motivated management team that is aligned with shareholders

• CEO Barry Goldstein has been in place since 2001 and is the largest shareholder, owning 12% of outstanding shares. Management collectively owns 29% of shares.

• Insiders have consistently purchased shares including the CEO recently buying shares on March 21^st, 2016.

• Management thinks like a shareholder because Kingstone’s stock represents a significant portion of management’s net worth.

• Employee bonus plan tied directly to GAAP combined ratio, creating alignment with shareholders.

Strong business mix

• KINS gross written premiums are derived from homeowner insurance (79%), commercial lines (11%), and livery physical damage (9%) which is insuring service vehicles and taxicabs.
  

• Personal lines are more consistently profitable than other lines because of shorter policy terms (1 year for homeowner) and small tail risks which allows for re-pricing as loss trends change. Also, person lines have higher barriers to entry because of granular distribution models due to small policy sizes and have generally rational competitors. KINS has had a combined ratio <100% for 18 of the past 20 quarters.
  

• 67% of pre-tax earnings are from insurance underwriting. 33% of pre-tax earnings are derived from net interest income from free float from the insurance operations.

• 97% of risks are located in NYC, Long Island, and Westchester. KINS does not take aggressive cat risk like some other publicly traded Florida homeowner insurance pure-plays.

• The company has 0.95% market share in NY State in 2015, up from 0.76% in 2014.

• Kingstone is licensed to do business in PA, NJ, CT, and TX, but management is prudently managing out-of-footprint growth. Other states will not be a material contributor in 2016, but likely will start to see growth in 2017.

Unique track record of disciplined underwriting and market share growth AND smart growth strategy

• Kingstone has averaged an 11.4% ROE since 2011, and ROE in the last 2 years has improved to 14.8% as the company increased scale and leveraged fixed costs. Management believes they can operate at 15-20% ROE going forward as they have for the last three quarters (22.6%, 21.3%, and 16.4%).

• Combined ratio of 83.2% (78.4% ex-cats) since 2011, last two years 79.4% combined ratio (72.8% ex-cats). Kingstone has had a combined ratio below 100% in 18 of the last 20 quarters.

• The company has grown gross premiums written at a 22% CAGR since 2011, and has grown net premiums earned at a 36% CAGR over the same period as management has reduced ceding and retained more of the underwritten risks as capital levels have grown.

• Consistently improved efficiency with underwriting expense % of premiums written falling from 18.1% in 2011 to 14.1% in 2015. Also, gross premiums written per employee has increased from $710,000 to $1,319,000 over the same period even as employee count has also grown from 38 to 69.

• The company has attractive financial model targets which include organic premium growth of 20%, margins of 20%, and ROE of 15-20%.

• KINS has built-in growth by reducing risk ceding. The company writes more business than management wants to retain with current capital levels. As the company builds capital and reduced ceded risks, KINS will scale up the business without taking new risks. In 2015, KINS ceded $30mm of written premiums vs net premiums earned of $60mm so has built-in capacity to grow the business by 50%. This is 2+ years of visible growth that only depends on growing the balance sheet and retaining more of the risk they are already underwriting.

Market underappreciates increased use of reinsurance which will result in a more consistent earnings stream going forward

• The market doesn’t appreciate KINS’s more consistent earnings stream due to increased use of reinsurance in the last 12 months. The business will consistently earn $0.20-0.35 per quarter (last three quarters $0.32, $0.32, and $0.25).

• The company has taken advantage of cheap reinsurance to reduce the combined ratio impact of a Sandy-Type event from 27.9% to 9.7%, a 65% reduction in earnings volatility since 2012.

• Another Superstorm Sandy sized event would result in just over one quarters worth of earnings or less than 10% of annual combined ratio (No longer a balance sheet event!)

Attractive Valuation

• A less volatile earnings stream results in multiple re-rating to 10-12x P/E. Based on $1.10 in 2016 EPS, KINS’s fair value at 10x would be is $11.00.

• Management targets 15-20% ROE which implies KINS should trades at 1.5-2.0x P/BV. KINS book value is $6.18/share today which implies a fair value of $9.27-$12.36. KINS 1 year forward book value is $7.09/share which implies fair value of $10.64-$14.18.

• 3% dividend will continue to grow with EPS growth, around 20% annually.

• KINS offers the opportunity to compound returns at 15-20% for 2-3 years (2+ yrs of growth from reducing ceded insurance) and possibly longer. It’s a good business that will create value for shareholders over time and that is also available at a discount to fair value today.

 Risks

• Underwriting results deteriorate from rapid growth in homeowner insurance.

• Pricing in NY becomes more aggressive from new or existing entrants.

• Catastrophe centered on NYC causes operating loss and reduces book value.

• Loss of key member of management team.

Differentiated approach to channel distribution

• Strong, consistent relationship with core smaller agents.

• Try to compete on service and reliability ahead of price.

• Granular distribution with 350+ agencies.

Catalyst

Continued and consistent growth in earnings and book value drives increase in intrinsic value, potentially with some p/e multiple expansion.