A Workers' Comp Provider as a Recovery Play

• ByJonathan Moreland, InsiderInsights Research Director
• On 11:59 am EDT, Thursday May 28, 2009

The wall of worry about the market's ability to keep surging is higher than ever -- and the indices keep climbing it. Even bulls who pounded the table about the bottom being in early March are voicing surprise at the rally's longevity.

I'm surprised myself, and in many of the positions I had used in order to play what I believed to be just another bear market rally, it seems I took profits too soon. While my tamed greed has still ended up giving the Recommended List of my InsiderInsights newsletter a solid 15% year-to-date return, I now find myself with a fairly high 25% cash cushion after my profit-taking.

Time will tell whether this cash will end up being smartly conservative as this aging rally finally takes a breather, or a drag on performance as indices thumb their noses at pessimists. Either way, however, there are still several stocks I'm willing to buy into, even after their recent appreciation. One of them is Employers Holdings.

Seeking Stable Clients

Employers specializes in providing workers' compensation insurance and services to small businesses in the U.S. The firm is well diversified in the types of businesses it covers, with the top 10 industries representing just 35% of its total written premiums. Physicians' offices and restaurants are the top two premium producers. They represent 6.8% and 6.5% of written premiums, respectively. Employers further mitigates risk by focusing on businesses with lower turnover and more experienced personnel. So fast-food restaurants tend not to be customers, while family-owned eateries are.

After aggregating state-run workers compensation programs under its corporate umbrella earlier this decade, Employers demutualized and came public via an IPO in February 2007. It's been downhill for the shares since then -- weakness that followed the downturn in the U.S. economy itself.

Insiders began signaling value in these shares last November, however, when eight executives purchased 11,300 shares of EIG at an average price of $13.66. More recently, 10 insiders purchased another 25,250 shares at an average price of $10.42 so far in May.

Though hardly large in terms of aggregate dollar value, the two clusters of insider purchases at Employers did increase the holdings of the individual executives substantially each time. Shares of Employers also have the attraction of not being either overextended or overpriced after the stock market's months-long party. To the contrary, this stock still appears to be below most investors' radar.

Employers' recent quarterly results and earnings estimates for this year show that insiders have a good point with their value argument. In the midst of this horrendous recession, the firm was able to earn 43 cents per share in its first quarter. That was lower than the 51 cents per share it earned in the prior year's first quarter, but that's to be expected, given the large increase in unemployment over that same time. Negative earnings-per-share comparisons will undoubtedly continue for the remainder of this year as well.

More important to me, however, was that the first quarter's results put the firm in good shape to earn at least $1.39 per share in 2009 -- which is the average of the large range of EPS estimates for Employers. EIG trades for just 9 times that expectation. That's low even for this low-multiple industry.

Feels Like a Trough

While present EPS estimates for 2010 aren't promising much bottom-line growth at Employers, next year is arguably too far away to predict. But even a curmudgeon like me believes that 2009 will likely be the trough for this recession, and my bet on Employers' shares assumes that $1.39 per share also turns out to be the trough in earnings for the firm. If this scenario plays out, I would expect this stock to benefit from multiple expansion.

As it is, larger peer Zenith National Insurance has been able to maintain a multiple of 15 times the highest EPS estimate for this year. Not only is Zenith unlikely to hit the high end of estimates, Employers has also managed better growth and profit margins as of late.

Robert Farnum, an analyst at Keefe, Bruyette & Woods, says, "Employers has also been more conservative than many peers when setting aside money for claims. They tend to set aside more than the claim itself, which can lead to positive earnings contributions if final payment is below the reserve amount."

And as poor as the timing of Employers' IPO was for shareholders two years ago, the growth strategy that justified the firm going public finally looks set to play out. Employers acquired AmCOMP late last year, a transaction that significantly diversified the geography of the company's policy exposure. If past is prologue, and if small businesses once again are at the forefront of job creation once this recession ends, Employers' newly widened base of operations and solid balance sheet should both prompt and support respectable earnings growth.

Granted, unemployment is inevitably going to increase first in the near future. But Employers is managing the downturn well thus far, maintaining its A-minus rating from the insurance rating firm A.M. Best and even executing a buyback of 1.6 million of its shares so far this year.

This all bodes well for Employers' shares when the economy finally levels off, and I view the firm as a relatively low-risk way to play a 2010 economic recovery in the U.S.

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Know What You Own: Other insurance stocks include Travelers Companies, ACE Limited, Chubb, Allstate and Hartford Financial.

Buzz up!