The Allstate Corp. NEUTRAL ZACKS CONSENSUS ESTIMATES (ALL-NYSE)

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1 February 20, 2015 The Allstate Corp. Current Recommendation Prior Recommendation Outperform Date of Last Change 02/20/2015 Current Price (02/19/15) $71.17 Target Price $75.00 NEUTRAL (ALL-NYSE) SUMMARY We are downgrading our recommendation on Allstate to Neutral given its weak underwriting performance in The fourth-quarter earnings surpassed the Zacks Consensus Estimate but lagged year over year. Lower catastrophe losses and operating expenses were more than offset by weak top line and higher claims frequency, marring underwriting results, combined ratio, net income and ROE. Improvement in P&C premiums were offset by lower capital and investment incomes, life and annuity premiums and contract charges. Cash flow weakened further, though financial leverage and book value improved. Continued synergies from decent capital position, divestment of redundant operations, pricing discipline and diversified mix aid efficient capital deployment, as reflected by new share buyback and dividend hike. Allstate s strategy of minimizing risk exposure and maximizing returns should mitigate cyclical declines and enhance earnings potential in the long run. SUMMARY DATA 52-Week High $ Week Low $51.79 One-Year Return (%) Beta 1.00 Average Daily Volume (sh) 2,626,299 Shares Outstanding (mil) 418 Market Capitalization ($mil) $29,749 Short Interest Ratio (days) 2.44 Institutional Ownership (%) 77 Insider Ownership (%) 1 Annual Cash Dividend $1.12 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 2.7 Earnings Per Share (%) 26.9 Dividend (%) 8.5 P/E using TTM EPS 13.1 P/E using 2015 Estimate 12.5 P/E using 2016 Estimate 11.5 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Low, Type of Stock Large-Value Industry Ins-Prop&Caslty Zacks Industry Rank * 52 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) ,463 A 8,787 A 8,465 A 8,792 A 34,507 A ,630 A 8,620 A 8,642 A 8,759 A 34,651 A ,768 E 8,874 E 8,979 E 8,055 E 34,676 E ,551 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 $1.35 A $1.12 A $1.53 A $1.70 A $5.70 A 2014 $1.30 A $1.01 A $1.39 A $1.72 A $5.42 A 2015 $1.41 E $1.32 E $1.26 E $1.69 E $5.68 E 2016 $6.19 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Founded in 1931 and headquartered in Northbrook, Illinois, The Allstate Corporation is the secondlargest property-casualty (P&C) insurer and the largest publicly-held personal lines carrier in the U.S. The company also provides a range of life insurance and investment products to its diverse customer base. Allstate provides insurance products to approximately 16 million households through more than 12,000 exclusive agencies and financial specialists in the U.S. and Canada. The company operates through its subsidiaries Allstate Insurance Company, Allstate Life Insurance Company and affiliates. As of Dec 31, 2013, Allstate had approximately 38,800 full-time employees and 600 part-time employees. The company primarily operates through three reportable segments: Allstate Property-Liability, Allstate Financial Group and Corporate & other. Property-Liability primarily underwrites policies relating to private passenger automobile and homeowners insurance in the U.S. and Canada. The company sells Allstate-branded policies through Allstate agencies and through the Internet, other than selling Encompass, Esurance and Answer Financial brand policies through its network of independent agencies. Allstate acquired Esurance and Answer Financial from White Mountains Insurance Group Ltd. for approximately $1 billion in Oct 2011, in an attempt to expand its online home-auto sales. Allstate Financial Group provides life insurance, retirement policies and structured financial products to individuals and institutions through Allstate agencies, independent agencies, financial institutions and broker-dealers. This segment also offers banking products and services to customers through the Allstate Bank. Corporate & Other consists of conducting holding company activities and certain non-insurance operations. Meanwhile, Allstate ceased the operations of Allstate Bank in 2011, after receiving regulatory approval to dissolve it. In Mar 2012, the company also annulled the bank s charter and as of Jul 1, 2012, Allstate is no longer a savings and loan holding company. More details will be provided following the release of Allstate s 10-K. REASONS TO BUY Prudent capital management remains Allstate s forte. The company is focusing on reducing its exposure to rising interest rates and real estate investments while maintaining a significant exposure to corporate credit to capture appreciation as soon as spreads tighten. As part of an aggressive debt refinancing plan in 2013, Allstate had repurchased $1.9 billion on long-term debt, issued $2.3 billion of long-term debt and issued $807.5 million of preferred stock. These simplified the company s debt profile and strengthened its ability to pre-redeem debt worth $250 million that was scheduled for maturity in Jun 2013 and senior notes worth $950 million, which were slated to mature in The debt-refinancing plan has further appreciated the equity portion in the capital, reduced borrowing costs and expanded the debt maturity profile to more than 20 years. These efforts have not only driven the book value but also scores well with the ratings agencies. Moreover, statutory capital levels remain sound and the company continues to have a strong liquidity position as it has access to $1.0 billion of funds from the new 5-year credit facility, extended in Apr 2014, along with a commercial paper facility with a borrowing capacity of $1.0 billion. Allstate also repaid its debt of $300 million that matured in May 2014, issued preferred stock worth $250 million in Jun 2014 and redeemed $650 million of debt in Aug 2014, while no maturities are scheduled until While total debt reduced 16.2% from the 2013-end level, it improved the total debt-to-capital resources ratio to Equity Research ALL Page 2

3 18.9% at 2014-end from 22.4% in 2013 and 22.7% in 2012, consistently below 24% scaled by ratings agencies. Going forward, we believe that effective capital management, a comprehensive enterprise stochastic model and modest operating cash flow will be able to boost the company s operating and competitive strength. Despite the sluggish recovery in the economy, the company has succeeded in improving its riskadjusted capitalization and capital adequacy. Management s proactive risk mitigation and return optimization programs continue to enhance operating cash flow and shareholder value, while generating operating return on equity (ROE) of 14.5% in 2013-end, against 12.4% in 2012, 3.8% in 2011 and 8.6% in Although ROE lowered to 12.6% at 2014-end, it stood quite close to the targeted ROE of 13% by Alongside, Allstate bought back stock worth $910 million in 2012, $1.84 billion in 2013 and $2.8 billion in The company completed two of its previous share repurchase programs way ahead of expiry and sanctioned another worth $2.5 billion in Feb 2014, further boosting it by another $750 million in Oct While this is scheduled to complete by Mar 2015, the board has authorized another share buyback program worth $3 billion in Feb Overall, the company has deployed about $26.7 billion of capital through share repurchases over the last 20 years, along with the 7% dividend hike in Feb 2015, which was backed by a 12% dividend rise in 2014, 13.6% in 2013, 4.8% in 2012 and 5% in 2011, after a sharp cut down in Armed with invested assets of $3.4 billion at 2014-end and modest cash flow, we believe that the company is sufficiently liquid and can continue to deploy capital without putting additional risk on financial leverage, thereby retaining shareholder confidence. Allstate is well positioned to be a long-term gainer in personal lines, given its scale, pricing sophistication and product design. The company s disciplined underwriting approach, favorable pricing and non-catastrophe operating results, as well as efficient operating expense management has led to a more consistent profitability compared with many of its peers. The Property-Liability segment is also benefiting from Esurance and Encompass brands, both of which contributed to majority accretion in premiums, policies-in-force and new business volumes in 2013 and in 2014, projecting earnings growth hereafter as well. Moreover, the impact of the past acquisitions and growth from emerging businesses have started reflecting in improved Property-Liability segment s net income of $2.75 billion in 2013, up from $1.96 billion in 2012 and $403 million in 2011, while total premiums earned rose 10.4% year over year in 2013 and 4.7% in Meanwhile, increased agency distribution has geared up unit sales at Allstate Financial. In Jul 2013, Allstate Financial announced that it will not issue fixed annuities post 2013, while beneficial modifications were made in employee benefit plans. However, the company intends to continue to offer these products through its alliance with ING U.S., tapping the rising demand for fixed retirement income products, overall minimizing risk exposure. Going forward, the sale of Lincoln Benefit Life (LBL) in Apr 2014 generated incremental synergies such as reduction in capital requirement at Allstate Life Insurance Co. by about $1 billion. The company also gained $38 million from the sale of Sterling Collision Centers in second-quarter Allstate also plans to outsource the annuity business management to a third-party administration company going forward, while strategically investing in technology upgrades. With an operations and capital strategy that enables acclimatizing to changing market regulations, Allstate is well positioned to benefit from an improving economy. Despite above-average catastrophe costs, the Property-Liability segment, which generates the majority of Allstate s revenue, continues to be profitable owing to pricing discipline and strong claim management. The company is also focused on driving sales of the homeowners and car insurance businesses, which do not significantly depend on interest rates, thus steering clear of the present low interest rate environment. Eventually, the improvement in interest rates and pricing will help Allstate hedge against market and uncertain catastrophe risks. Moreover, given the vehement catastrophes that occurred during the past few years, the industry has been raising premiums and reinsurance rates to absorb the heavy costs while boosting revenues and investment gains. This is also being taken positively by the clients who are now developing awareness on the importance of Equity Research ALL Page 3

4 property and life insurance, thereby creating demand and generating healthy growth prospects for the company. The rate increases are expected to continue in the near term. Allstate has also repositioned its product and distribution portfolio with a customer-focused strategy to enhance longterm growth. Additionally, the company initiated an active role to reduce future catastrophe losses through the establishment of an Enterprise Risk and Return Management (ERRM) system, which also aided the improvement of the underlying combined ratio in 2012, 2013 and Consequently, underwriting income surged 85% year over year in In line with the 2014 goals, Allstate aims to continue working vigorously in 2015 to improve insurance policies-in-force and underlying combined ratio, modernize operating model, aggressively manage capital to generate higher risk-adjusted returns and strengthen base for long-term growth. We expect these initiatives to boost the bottom line from current-levels in the upcoming quarters. REASONS TO SELL As Allstate deals with property and casualty business, it is significantly exposed to catastrophic events. Given the consistent occurrence of weather-related events, catastrophe losses had surged to $2.35 billion in 2012 and $3.82 billion in 2011, radically exceeding from $2.21 billion in 2010 and $2.07 billion in 2009, weighing on the company s claims and benefits expenses and cash flow. Although catastrophe losses were lower over prior-year period, it escalated to $1.25 billion in 2013, and again surged to $1.99 billion in 2014, due to above-normal winter storms, fire-related, reinsurance and reserve losses, also deteriorating the underwriting income and combined ratio during the period. Notably, operating cash flow also plunged to $3.24 billion in 2014, after improving to $4.24 billion in 2013 from $3.1 billion in 2012 and $1.9 billion in Though the company is focusing on reducing losses through its catastrophe management strategy and reinsurance programs, while continuing to maintain its underlying combined ratio at levels of 87 89% in 2015, we cannot rule out the possibility of significant losses from catastrophes and severe weather incidents, going forward. Rapid changes in climate that cause winter freezing, typhoon and tornadoes as well as the strong likelihood of earthquakes in California are expected to inflate catastrophe losses in the future. Allstate struggles to maintain its position in a highly competitive industry, which is marked by the escalated pricing pressures and selective underwriting standards. While spreads between premium growth and loss cost inflation are expected to remain negative, operating and advertising costs as well as claims expenses continue to pose a rising trend, leading to further compression in the underlying margins and earnings. Moreover, the company is experiencing sluggishness in the Allstate brand homeowners policies, given the negative impact of rising returns, reduced policies-inforce and intense competition within homeowners insurance. Additionally, pace of premiums growth has decelerated in the Esurance brand. These factors also adversely affected the operating costs of the Property-Liability segment, which increased 6.1% year over year in 2013 and 2.3% in Sluggish premiums, higher claims and lower investment income also reduced the net income of this segment by 11.9% year over year to $2.43 billion in Going ahead, the cyclical nature of the property-casualty business is more likely to hamper operating costs and underwriting results, which fell 20.1% to $1.77 million in Further, Allstate s investment portfolio has been witnessing a rough patch due to the ongoing equity market declines and sluggish returns. As a result, net investment income had shrunk to $3.97 billion in 2011 from $4.10 billion in Although it rose marginally to $4 billion in 2012, most of the upside being the result of limited partnerships, net investment income declined 1.7% to $3.94 billion in 2013 and 12.3% to $3.46 billion in 2014, thereby significantly diminishing the overall investment portfolio. Net investment income is expected to remain weak until the interest rates rise and maintain stability. The ongoing sluggish and volatile economic dynamics and increased credit exposure pose credit and financial risk, which is also validated by Allstate s higher debt and statutory capital that lag Equity Research ALL Page 4

5 the pre-financial crisis levels. The company also incurred a loss on extinguishment of debt of $319 million in These financial risks had consistently deteriorated Allstate s debt-to-capital ratio in period. Although it improved in the last few years, most of the upside stemmed from a higher capital base, any volatility in which may raise caution for future. As a result of the volatility in the capital markets, Allstate has been pursuing strategies to narrow its product offerings under its Financial Segment. The company has reduced concentration in spreadbased products, which has led to a drop in sales in this segment, resulting in reduced premiums and contracts charges as well as lower investment income in The segment s bottom line continues to be volatile, declining 8.3% year over year to $541 million in 2012 and then plummeting to $95 million in 2013, primarily due to loss of $514 million incurred from the sale of LBL, volatility in investment income, realized capital gains and higher expenses. Although net income in this segment rose in 2014, the escalation was primarily due to heightened loss from discontinued operations in the prior-year period, as well as strong limited partnership income and lower expenses, while the top line remained weak. Higher competition and changes in regulations further raise the likelihood of negating demand, validating our cautious outlook. RECENT NEWS Allstate Beats Earnings, Hikes Dividend & Share Buyback Feb 4, 2015 Allstate s reported fourth-quarter 2014 operating earnings per share of $1.72, comfortably surpassing the Zacks Consensus Estimate of $1.67 by 3%. Moreover, reported earnings beat the year-ago quarter figure of $1.70 a share, primarily on lower share count. However, operating net income fell 5.8% to $736 million. Including extraordinary items, Allstate s reported net income stood at $795 million or $1.86 per share against $810 million or $1.76 per share in the prioryear quarter. Property-liability insurance claims and claim expenses rose 7.8% year over year to $4.62 billion, while operating expenses decreased 8.1% year over year to $1.16 billion. Notably, catastrophe losses for the reported quarter declined 18.8% to $95 million. Allstate s net revenue edged down 0.4% year over year to $8.76 billion. However, top line exceeded the Zacks Consensus Estimate of $7.64 billion. Quarter in Detail Property-Liability s earned premiums were $7.35 billion, up 4.8% from the prior-year quarter, primarily driven by decent performance across the Allstate, Encompass and Esurance brands, modest growth in new business and customer retention across standard auto and personal lines businesses. Policy rates in the homeowners segment also showed marginal improvement. Moreover, net written premiums grew 4.9% year over year within the Allstate brand, whereas total policies moved up 2.5% reflecting improvement in auto and personal lines. The Encompass brand witnessed a 5.1% increase in net written premiums and 1.8% in policies. Esurance posted 14% growth in net written premiums and 12.6% in policies. The segment s combined ratio deteriorated to 90% from 88.7% in the year-ago quarter. The underlying combined ratio, which excludes catastrophes and prior-year reserve estimates, was 89.5% in the reported quarter, up 2.0 points from the year-ago quarter, due to higher claims frequency. This was also higher than management s outlook of underlying combined ratio of 87% to 89% for Equity Research ALL Page 5

6 Meanwhile, underwriting income declined 7.2% to $737 million owing to higher claims, operating and other expenses. However, the Property-Liability expense ratio for the reported quarter was slightly lower at 27.2% against 27.6% in the prior-year quarter. Subsequently, lower investment income and underwriting results, partially offset by lower catastrophe losses, weakened Property-Liability s net income to $666 million from $865 million in the year-ago quarter. Operating income for this segment also declined to $687 million from $793 million in the yearago period. On the other hand, operating income for Allstate Financial reduced to $128 million from $160 million a year-ago, primarily due to the divestment of Lincoln Benefit Life (LBL). Lower net investment income, premiums and contract charges were partly offset by lower benefits and interests charged against contract funds, along with lower operating expenses and deferred amortization costs. However, net income grew to $208 million from $119 million in the year-ago quarter, primarily owing to gain on disposition of operations and higher realized capital gains. Corporate & Other reported a net loss of $79 million, narrower than the loss of $174 million in the prioryear quarter. The improvement came primarily on the back of substantially lower operating expenses in the current quarter. Investment and Capital Position As of Dec 31, 2014, Allstate s total investment portfolio dipped to $81.11 billion from $81.16 billion at 2013-end, reflecting total portfolio returns of 5.8%. However, annualized portfolio yields were 4.2% at Dec 2014-end, slightly down from 4.6% at 2013-end. Allstate s net investment income tanked 24.1% year over year to $779 million in the reported quarter primarily owing to reductions related to the LBL divestiture, persistently low interest rates and constant planned reduction in deferred annuities. While limited partnership income remained strong in 2014, it was partially offset by low interest rates. Book value per share increased 6.5% year over year to $48.24 in the reported quarter. Excluding the impact of unrealized net capital gains and losses on fixed income securities, book value climbed 4.2% to $44.33 a share at the end of Additionally, annualized operating ROE deteriorated to 12.6% from 14.5% at 2013-end. Operating cash flow plunged 23.7% year over year to $3.24 billion at the end of 2014, while cash stood at $657 million against $675 million at 2013-end. Total equity increased to $22.3 billion from $21.48 billion at 2013-end, while total assets declined to $ billion at the end of 2014 from $ billion at 2013-end. Long-term debt decreased to $5.2 billion from $6.2 billion at 2013-end. Additionally, total debt to capital ratio improved to 18.9% at 2014-end from 22.4% at 2013-end, as the company repaid debt worth $950 million and issued preferred stock worth $998 million during the reported quarter. Stock Repurchase Update Allstate bought back shares worth about $1.4 million through open market operations during the reported quarter, while a total of $2.8 billion shares were repurchased in 2014 (higher than $1.84 billion in 2013). Equity Research ALL Page 6

7 On Oct 29, 2014, the board expanded the $2.5 billion share repurchase program, authorized in Feb 2014, by another $750 million. At the end of 2014, Allstate had about $336 billion shares available for repurchase under the current authorization. This is expected to be complete by Mar 2015, and followed by a new share repurchase program worth $3 billion, authorized concurrently, which will expire by Jul Dividend Update Concurrently, Allstate also hiked its regular quarterly dividend by 7.1% to $0.30 from the prior $0.28 per share. The increased dividend will be paid on Apr 1, 2015, to the shareholders of record as on Mar 2. Thus, the company is now shelling out $1.20 per share annually. On Jan 2, 2015, the company paid a regular quarterly dividend of $0.28 per share to shareholders of record as on Nov 28, In Feb 2014, this dividend was hiked by 12% from the prior payout of $0.25. Outlook Allstate aims to record the underlying combined ratio between 87% and 89% in Equity Research ALL Page 7

8 VALUATION Allstate shares currently trade at 12.5x our earnings estimate for 2015, at 16% discount to the 14.9x industry average. On a price-to-book basis, the shares trade at 1.5x, at 15% premium to the 1.3x industry average. The valuation on a price-to-book basis looks attractive, given a trailing 12-month ROE of 11.9% that is higher than the 9.5% industry average. Our six-month target price of $75.00 per share equates to about 13.2x our earnings estimate for Combined with the $1.12 per share annual dividend, this target price implies an expected total return of 6.2% over that period, which is consistent with our Neutral recommendation. Additionally, the quantitative Zacks Rank for Allstate is currently 3, indicating no clear directional pressure on the shares over the near term. Short interest is currently 2.4 days. Key Indicators P/E F1 P/E F2 Est. 5-Yr EPS Gr% P/CF P/E P/E 5-Yr High P/E 5-Yr Low The Allstate Corp. (ALL) Industry Average S&P Tokio Marine Holdings Inc. (TKOMY.PK) 11.1 NA NA 11.0 MS&AD Insurance Group Holdings Inc. (MSADY) 14.7 NA The Travelers Companies (TRV) Ace Limited (ACE) TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA The Allstate Corp. (ALL) Industry Average S&P NA 2.1 NA Equity Research ALL Page 8

9 Earnings Surprise and Estimate Revision History Equity Research ALL Page 9

10 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of ALL. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform %, Neutral %, Underperform 7.8%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Research Analyst Copy Editor Lead Analyst QCA Meenakshi Sharma Sayantani Sinharoy Meenakshi Sharma Tanuka De Equity Research ALL Page 10