Tuesday, April 7, 2020

Unintended consequences of Corona - Positive view for income investors

Unintended consequences of Covid-19 include less crime, reduced spread of communicable diseases, fewer auto accidents.
  • Fewer miles driven makes for few accidents
  • Auto insurers should benefit from fewer accidents and payouts.
  • Looking for a stock with an A rating.
  • Looking for an insurance stock with a high yield
  • Looking for a stock that is optionable
Sad as this Covid-19 experience has been for everyone, there are some positive consequences.  Governor Cuomo commented on a reduced crime rate.  With the social distancing and the wearing of masks and the unrelenting hand washing, we have to be reducing the incidence of communicable diseases in general.

Another unintended consequence is driving behavior. With stay at home behavior, people are driving and even riding in cars fewer miles and fewer hours.  Fewer miles driven translates to fewer accidents.  This is an interesting article on the impact of recessions and other events on traffic.  https://www.cccis.com/2020/03/20/how-claim-and-accident-frequency-may-be-impacted-by-covid-19/ .   This morning on my local news channel we learned that auto accident deaths in our State are down.

With out a doubt we will have fewer auto accidents and that should lead to fewer claims paid by insurers.  That makes me look for an auto insurer to add to my portfolio.

In my portfolio, I own Prudential, symbol PRU.  But I no longer own a property and casualty insurer.  In 2017, I wrote up a post that applied my dividend machine fundamentals to a group of insurers.  I ended up owning several of those but they were all either called away on options or I sold them for other reasons as their prices increased.  That link is below.

Today, I looked at a bunch of insurers including:  MKL, SAFT, HIG, CB, MET, AIG, MCY, PRA, and CNA. Out of this group, the best yield is MCY and it is the most pure property and casualty play.  SAFT has a good yield and generates most of its business from private passenger auto insurance.  But, SAFT is limited to the North East.  

Another factor that determines which of these stocks I want to pursue is their credit rating.  For insurance companies there are several credit rating agencies.  AM Best and Fitch are two that are well known.  While MET has an A+ rating by AM Best it really is not as pure a play on auto insurance.  Take a look below at the credit rating categories of insurers.



CategoriesRating symbolsRating notchesComments
SuperiorA+A++
Assigned to insurance companies that have a superior ability to meet their ongoing insurance obligations
ExcellentAA-
Assigned to insurance companies that have an excellent ability to meet their ongoing insurance obligations
GoodB+B++
Assigned to insurance companies that have a good ability to meet their ongoing insurance obligations
FairBB-
Assigned to insurance companies that have a fair ability to meet their ongoing insurance obligations
Financial strength is vulnerable to adverse changes in underwriting and economic conditions
MarginalC+C++
Assigned to insurance companies that have a marginal ability to meet their ongoing insurance obligations
Financial strength is vulnerable to adverse changes in underwriting and economic conditions
WeakCC-
Assigned to insurance companies that have a weak ability to meet their ongoing insurance obligations
Financial strength is very vulnerable to adverse changes in underwriting and economic conditions
PoorD-
Assigned to insurance companies that have a poor ability to meet their ongoing insurance obligations
Financial strength is extremely vulnerable to adverse changes in underwriting and economic conditions

SAFT carries a BBB+ rating.  Whereas, MCY carries an A rating.  Both are acceptable but I like A over triple B plus.  

Once I narrowed this group down, I look at dividend fundamentals that I use for every dividend stock I add.  Here is how MCY stacks up.

MCY Annual EPS Annual Div
  Earnings>Dividend $5.78 $2.52
  Debt to Equity Ratio 0.23
  Dividend Yield 6.45%
  3 Yr. Rev. Growth
6.08
  3 Yr. Div. Growth 0.03%
  Cash Flow/Share $9.39
  P/E Ratio 6.5


Mercury General has a long history and that is so useful when making the decision to add a new position.  Looking at the table above, MCY shows me that earnings are adequate to pay the dividend and that yield is hefty at 6.45%.  I also see a D/E ratio that is low but typical of insurers.  Revenue has adequate growth and P/E ratio is down right cheap.  

The only negative I see is the lack of dividend growth.  I will take the big yield on a solid balance sheet while I work shares to maximize income while this low accident rate catalyst works.

When I add a new position, I want good yield, a solid balance sheet, a solid history of dividend payments.  Looking back on their history during the 2007-2009 market disruption, I see a stock with a solid history of paying the dividend through thick and thin.  

Fr
      Graph from DividendChanel.com



I also like a stock that is optionable because I make a lot of extra money selling calls on my dividend stocks.  I don't want to necessarily lose all my shares should I be called away, therefore, I sell calls on only a portion of my position.   Each call requires 100 shares.  If I own 500 shares, I might sell 2 calls and keep the other 300 shares un encumbered by a call option.

I started this article on 4/6/2020 but executed the trades today 4/7/2020.  As soon as I bought my shares, I sold this call.

Price on Open Call Expiration 
MCY $40.11 6/19/2020
Cost Basis:   4/7/2020 $39.90
Strike Price: $45.00
Call Premium:  $1.25
Dividend  6/16/2020 $0.630
Call Yield on Basis 3.13%
Call + Dividend Yield on Basis 4.71%
$ Gain if Assigned $6.98
Max Return  if Assigned 17.49%

We all hope this crises is shorter lived than we currently expect.  Moreover, we hope the underlying business of America goes on. Currently the options buyers are out there and that is most important for income investors, like me, who use a covered call strategy for income maximization.


M* MoneyMadam

3/29/2017 Post on Insurers http://www.themoneymadam.com/2017/03/next-2017-dividend-machine-insurer.html

Expect to add MCY and expect to sell calls against a portion of the position.