HCI Group Stock: A Technology-Driven Home Run on Florida’s Insurance Market (NYSE:HCI)

thesis

HCI Group, Inc.(HCI), a Tampa-based holding company, oversees businesses in homeowners insurance, reinsurance, real estate and IT. They began in 2006 as Homeowners Choice, Inc. In 2013, they changed their business operations and became HCI Group, Inc. to better represent their expanded business offerings.

HCI has a strong presence in the property and casualty insurance space through its largest subsidiary, Homeowners Choice Property & Casualty Insurance Company, Inc., which insures homeowners in Florida. The company also develops insurance administration and claims management technology and invests in commercial and residential real estate.

The HCI business areas:

• TypTap Insurance: Property and flood insurance – better risk management with the help of technology.
• Homeowners Choice: Property and casualty insurance, primarily for homes in Florida.
• Greenleaf Capital: consolidates HCI’s real estate operations and includes residential, commercial and industrial properties.
• Claddaugh Casualty: Reinsurance to support HCI’s insurance business.
• Exzeo: Technology for insurance (data analysis and forecasting tools).
• CORE (Condo Owners Reciprocal Exchange): tailor-made insurance for condominium associations and owners.

Wall Street is very optimistic about the stock (it is also included in the Russell 2000 and S&P SmallCap 600 indices). Analysts largely agree and see an upside potential of about 46%.

Compared to its peers, HCI is doing very well, with a strong 66% increase over the past year. It is neck and neck with IGIC, which grew slightly more at 69%.

According to my analysis, HCI Group has strong financial performance, especially in the second quarter of 2024. Its non-GAAP earnings per share were reported at $4.21, beating expectations by $0.67, and its revenues were $206.25 million, above estimates by $8.91 million.

Although their operations in hurricane-prone Florida (always) involve risk, their advanced technology, solid underwriting performance and strategic policy underwriting have significantly increased profitability. I believe HCI is an undervalued stock with significant upside potential.

HCI Group earnings highlights in the second quarter of 2024

HCI Group reported solid financial results earlier this month, with pretax earnings of $76 million for the second quarter of 2024, resulting in diluted earnings per share of $4.24.

The company’s high profitability stands out. The big gain resulted from a 45% increase in gross written premiums to $264 million (around $1 billion in policies in force). This growth came primarily from Florida, where policies in force increased by 40%. CFO Mark Harmsworth says that “excluding acquisitions” the business is on a solid path to $250 million.

Speaking of growth, let’s look at Seeking Alpha’s HCI growth numbers:

The company is unbeatable when it comes to revenue and EBITDA growth. Last year, revenue grew by 41.48% and future growth is forecast at 18.59%. HCI is beating the sector hands down (YoY EBITDA growth), is clearly growing at a rapid pace and is converting revenue growth into earnings growth at a healthy pace.

Going back to the recent Q2, the company had a better underwriting ratio, with the gross loss ratio falling to 29.7% from 34% last year. In the first half of the year, the consolidated gross loss ratio was 30.4%. According to CEO Paresh Patel, their technology (which was mentioned frequently in the earnings call) has significantly improved their underwriting results, helping them to thrive in “tough times” and perform even better when conditions are favorable. Simply put, he says their technology has been one of the key drivers in achieving better loss ratios in recent quarters.

COO Karin Coleman said:

…the loss ratio was better than expected. This remains the case as we gain experience with this book. The loss ratio for the Citizens policies we have underwritten continues to be better than expected. Given the proven success of our technology in selecting attractive Citizens policies, we have applied to underwrite additional Citizens policies.

What is so special about this technology?

HCI Group uses AI (machine learning) to read and interpret large amounts of information from countless sources. Instead of a human underwriter on site, it is like a super-intelligent detective that can read not only the usual suspects (e.g. old claim forms from the insurance company’s database) but also new and potentially unusual data such as smart home or social media data or even information from fitness apps.

This technology allows HCI to capture patterns and risks that human operators – relying on simple or obvious data – might miss. When put together, the billions of points in HCI’s information network tell a smarter risk story about a given potential policy and the price HCI sets. This means they can set more accurate prices – fairer for the customer and better for the company’s bottom line.

Another positive indicator was the reduction in the combined ratio to just under 68%, a significant improvement from last year’s 90%. Even after adjustments, it remained around 80%, which represents solid progress. The decline in the combined ratio can be attributed to lower losses, pricing changes made last year, and increased efficiency. For example, labor and operating expenses now account for 9.5% of the company’s premium income in the first half of this year, up from 11% last year. And once again, HCI Group’s technology was credited with helping the company grow without spending much more, which boosts profits.

Investment income jumped, almost doubling to over $16 million, due to higher interest and higher invested balances. HCI Group’s balance sheet also grew significantly. Consolidated cash and investments grew by $390 million. Debt decreased by $70 million and equity increased by $259 million. The debt ratio improved from 62% to 34%.

Insurance retention rates, particularly for Citizens, exceeded forecasts, reaching nearly 85% instead of the expected 65%. HCI also completed its annual reinsurance program and expects to spend approximately $92 million each quarter on solid coverage. And finally, the company kept its promise to shareholders, paying a quarterly dividend of $0.40 per share for the 55th consecutive year.

Evaluation

HCI’s blended P/E of 8.93x is well below its fair value ratio of 15.00x and, more importantly, below its normal P/E of 15.75x. Compared to its historical benchmarks HCI seems to be undervalued and could be a good buying opportunity given its strong earnings and growth prospects. Its earnings growth rate of 14.84% supports the undervaluation and easily beats many competitors.

Additionally, the EPS yield is a respectable 11.20%, meaning the company is generating decent profits relative to the share price – and combined with the modest dividend yield of 1.68%, this makes a good case for HCI as an investment. The dividend is sustainable, there is some income to be earned, and all of this data is consistent with the statement that with the strong earnings growth, there will be further share price gains if HCI continues like this.

Seeking Alpha’s valuation metrics back up the undervaluation story with data that reflects a stock that is severely undervalued relative to its sector and past performance. With a non-GAAP P/E (TTM) of 7.61, it is 36.58% below the sector median and 62.71% below its five-year average. The market may be missing out on this stock’s earnings potential. The forward P/E is also well below its five-year average, suggesting the market is not fully realizing its future earnings potential.

Other key metrics such as EV/EBITDA (TTM) and EV/EBIT (TTM) support this. Both are rated A+ and show discounts of over 70% compared to the industry average.

That’s huge. EV/EBITDA (TTM) is nearly 94% below its five-year average. That suggests HCI is trading at a large discount to its enterprise value, which could mean strong upside potential if fundamentals hold or improve.

Risks and headwinds

But despite these solid results, there are still red flags in the industry. Large CAT (“natural catastrophe”) events like Hurricane Debby pose significant risks. Reinsurance costs, expected to reach $92 million per quarter, could erode profits if not managed properly. And more companies are taking on Citizens’ policies, which could make it harder for HCI to stay on top.

Last quarter’s loss ratios looked good, but the company is still heavily weather-dependent, which is a big problem considering it’s based in my hurricane-prone home state of Florida. While litigation and claims numbers are still declining, they’re still a headache and could also threaten the company’s stability. The future? Who knows. If HCI’s technology efforts are as successful in other areas as they have been here, they could still be the company’s secret weapon. However, HCI is heavily dependent on premium growth from its Citizens policy acquisitions, which could still be pretty shaky if retention or acceptance rates change.

Reviews

I would recommend the HCI Group as a buy.“. This company is doing very well financially, especially heading into Q2 2024. It is definitely undervalued, which means this stock has (potentially) a lot of upside. Although Florida is a risky place, their technology and effective underwriting have made this a solid investment.