Palomar: Understanding Its High-Risk Profile
- By Jacob Maslow
After pricing on the low end of its initial range, Palomar Holdings Inc. (PLMR) has performed well since going public in April. The company launched its IPO at a price of $15 and raised $84 million according to Nasdaq. Shares hit a high of $19.30 on the first day of trading. Monday saw the stock break the $20 barrier, reaching a peak of $20.24 before pulling back to close at $19.98. A mild round of profit-taking saw the stock pull back to $19.17, before rebounding and trading around the $20 mark ever since. Palomar Holdings closed at $19.88 on Friday, down 0.60%.
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The intrinsic value of PLMR
Speciality insurance
Palomar is a specialty insurance company that is fast-growing, seems reasonably priced and hits many of the targets one looks for in an IPO. But despite these positive signs, the business model carries significant risk, which will only worsen in the years to come and does not match the earnings from larger competitors. Short-term investors may be able to rack up some gains, but a safer play is to avoid this IPO altogether.
In its filing with the Securities and Exchange Commission, the company said it focuses on "certain markets that we believe are underserved by other insurance companies, such as the markets for earthquake, wind and flood insurance." The California-based company was founded in 2014 and initially focused entirely on earthquake insurance before moving into the other two areas. It has seven lines of business, which generally fall into one of the three aforementioned categories, and has made real efforts to diversity its business over the past several years.
Nevertheless, Palomar remains highly dependent on the California earthquake insurance market. In 2018, 67% of its gross written premium came from residential earthquake insurance. California and Texas represented its largest two states with 53% and 21% of premiums.
The company uses data analytics and its experienced management team to help mitigate risk, but the fundamental fact is that a bet on Palomar is a bet that California will not be hit with an earthquake anytime soon. Maybe there will be, maybe there won't. In April 2018, USA Today reported a seismologist said "there is a 99.9% chance that there will be a damaging quake (magnitude greater than or equal to 6.7) somewhere in California in the next 30 years."
Palomar counters such concerns by arguing that it purchases reinsurance and also notes its earthquake insurance does not cover fire damage resulting from an earthquake. It claims that if an event the equivalent of the 1906 San Francisco earthquake should occur, its hypothetical net loss would be capped at the current net retention of $5 million, equivalent to 5.2% of total shareholder's equity as of Dec. 31.
Statistics like that are often tossed about only to not deal with the reality of an earthquake, so many experts believe wind and flood insurance may grow riskier in coming years due to climate change. I can also imagine that residents who discover their home being burned down as a result of a catastrophic earthquake is not covered by Palomar may have a negative impact on the company's reputation, let alone the possibility of government intervention.
Risk is a natural part of dealing with IPOs, but this is risk for which no investor can easily predict nor prepare for. Palomar needs to offer more than the average insurance company can if investors are going to accept the risk.
Risk not worth the reward
Palomar's financial records may seem good at first for an IPO. G ross written premium s rose from $82 million in 2016 to $154 million in 2018, and total underwriting revenue rose from $40 million to $72 million. Furthermore, the insurance company is the rare IPO which is both profitable and growing, reporting net income of $18 million in 2018. Palomar is also cash flow positive. A market cap of $425 million seems reasonable given its revenue stream.
While this may be excellent numbers for most IPOs, the rules are a little bit different for insurance companies as the key is what earnings they can give to their investors. Palomar reported 2018 earnings per share of $1.07. By comparison, Allstate's (ALL) earnings were $5.96 in 2018 while Progressive (PGR) was $5.03. Earnings that low also indicate the company's inability to withstand a sudden shock.
Palomar may be worthwhile in the long run if it can continue to boost its earnings potential, particularly through diversifying away from the California earthquake insurance market. But until that actually happens, we are looking at a company which could lose a great deal should a major California earthquake occur. Betting that earthquakes and floods will lessen in intensity over the next few years to decades seems like a foolish bet, which is what going long on Palomar entails. Investors will be better off dealing with more established insurance companies, which can better stomach sudden catastrophes, and wait for a less risky IPO.
Disclosure: The author has no stake in any of the listed equities.
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This article first appeared on GuruFocus.
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The intrinsic value of PLMR
