Bancinsurance Corporation ( BCIS.pk ) is cheap. Hella cheap. Maybe you've also seen it come up on one of your screens. At $6 it's trading around 4.5x earnings, and slightly under tangible book value. It has an active insurance business that has been solidly profitable.
So why is it so cheap? Well I took a quick pass through it's latest 10Q to find out. First, it went through a period a couple years ago where it expanded into underwriting bail & immigration bonds and had to take some big writeoffs before they shut it down. It also lost an auditor during that period and had to refile financials to clean up the mess. But it's cheap for some other reasons as well.
Let's figure out what their real earning are. First, they sold a small publishing operation they had that did governmental and legal publishing. This is adding 50 cents per share (pre tax $2.5M "Net realized gain on sale of affiliate") to 2006 earnings. They've also taken $952k in losses from their discontinued bail bonds programs that probably won't recure in the future. This turns the 9 month after tax profit of $5M into something closer to $4M, or about $5.3M annualized.
Free cash flow appears higher than earnings with an annualized benefit of about $400k in depreciation over capex costs. So our P/FCF ratio is about 5.3. Still pretty cheap. Another way to look at it is to invert the free cash flow ratio to get a yield. That's how we would look at it were we to buy all the shares at $6, and distributed all of the free cash flow to ourselves. In that case, our investment would yield close to 19% per year. As Borat would say "very nice!".
But we aren't the owners, so we don't have any say on whether that free cash flow will be returned to us, or reinvested at a good rate. So how likely is it that the current management would do that?
That's where we start to find some hair. Let's start with the positives, Si Sokol and his family own over 50% of BCIS. It's nice to have a huge ownership stake in the hands of someone, because this should mean they'll ensure that profits are reinvested well, or returned to shareholders if they can't. But their track record isn't so good. They had majority control when that huge mistake was made with bail bonds. And in the 10Q, I find out than in only 9 months the company diluted shareholders 5% distributing stock options to employees. That's a huge level of dilution, if they did this annually it would reduce that juicy 19% yield to 14% in one fell swoop.
Let's move on to the remaining insurance business. Another red flag pops up as it's revenues declined almost 10% in the first 9 months of 2006 compared to 2005, primarily because they lost an agent. That's not the sign of a strong business with competitive barriers (a moat). Also, their combined ratio has increased lately to over 100%. That's not good.
For those who don't know what a combined ratio is, it's a measure of how profitably an insurance company is writing business. If the ratio is below 100%, it means the insurer is writing profitable policies. If it's above 100% it means they are losing money on each policy they write. In many cases it's okay to write at break even or even a little above 100% because insurance companies can make up the losses by investing the customers premiums and earning investment returns. BankInsurance has about $50M invested out of customer premiums, and is earning about $3.6M annually in interest. This means they could run their $50M in annual premiums at a 107% combined ratio and break even. Running at 100% would only give them about 40 cents per share in earnings. So they need to run below 100% for this business to be significantly profitable.
The good news is part of the cause of this last quarter increase in combined ratio is writeoffs from the defunct bail bonds business. Without it, the combined ratio would have been 95%, good, but still higher than last years 89%. But how accurate are their loss reserves? The biggest problem with valuing an insurance company is that management can have the ability to defer losses, and make the underwriting ratios look healthier than they really is. The strongest defense is a solid management team with impeccable ethics, and I don't yet know if we have that here.
At first glance BCIS seems to carry excess cash on the balance sheet, but when I look closer I see they are carrying 17M in expensive debt. This is probably a requirement for their credit rating, but carrying debt means that they aren't as well capitalized as one would hope. I don't know how much they need to carry, so one of my next tasks would be to analyse this and see if there is excess cash that shareholders might be able to see in a dividend down the road.
So to sum up, I would describe BCIS as a fair business at a good price, as opposed to the good business at a fair price we'd prefer. It's not a "cigar butt" a company super cheap but heading out of business, this is just a very cheap business that is in a slight decline without any clear tangible competitive advantages. Right now I don't have a good read on the management and ownership's goals and track records, and since I haven't read a 10K, their long term performance is unclear. I'll be reading that next and if it sheds any light, I'll post an update.
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