Tower Group Inc. – Niche Market – Nice Stock

Categorized | Long Ideas

Tower Group Inc. – Niche Market – Nice Stock

Posted on 10 January 2009

The failure of AIG last year cast a disturbing light on the insurance segment. While many policy holders believed that choosing a large company for their insurance needs would be the most conservative course of action, it actually turned out that the blue chip names carried more risk. But despite the difficult environment, there is a small cap name in the sector that currently stands out as an attractive investment.

Tower Group, Inc. (TWGP) is a niche property casualty insurer that primarily serves small business in New York City. The business model is unattractive to large P&C insurers because of the amount of work necessary to evaluate small businesses and the small amount of revenue received per client. But since this segment is overlooked by the major insurers, Tower Group is able to command premium pricing for its policies and is operating in a profitable manner.

For the third quarter, the company saw net income of $16.7 million, 27% higher than the $14.4 million seen in 2007. This equates to 0.79 cents per share which is impressive given a challenging market in the third quarter. The company is guiding for full year earnings of $2.80 to $2.90 per share and expects 2009 earnings to be $3.20 to $3.40.

Currently, there are two acquisitions in progress that will allow TWGP to expand their geographical footprint. Hopefully the company will be able to take the success seen in the NYC market and apply it in the southeast with the purchase of Castlepoint Holdings as well as Hermatage Insurane Group. The company now holds licenses in 11 states, so its expansion options are firmly in place.

Management prides itself on conservative fiscal practices. The balance sheet is in good shape with a reasonable amount of debt. The last two acquisitions actually add to capital levels and give the company the opportunity to take extra capital from the acquisitions and apply it to the most needed areas. Still, Tower Group did not escape the financial turbulence unscathed. Most recently, it took an impairment charge against its investment portfolio. There were 12 securities made up of corporate bonds and residential mortgage backed securities which were written down to the tune of $5.6 million. This type of write down has been seen across the industry, but because of its low leverage, charges like this do not place the company in harms way.

The stock responded positively to the third quarter release and is now trading at near $27. If earnings due come in between $3.20 and $3.40 over the coming year, it would appear that the stock is selling for a relatively attractive price. In the coming months as markets begin to look more closely at individual securities and less at broad groups, TWGP should stand out as a leader in its class. I expect the stock to trade to new highs by the end of the year if not in the first two quarters.