AXIS Capital Holdings Ltd.

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1 March 20, 2015 AXIS Capital Holdings Ltd. Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Outperform Date of Last Change 07/24/2013 Current Price (03/19/15) $51.45 Target Price $ Week High $ Week Low $43.15 One-Year Return (%) Beta 0.78 Average Daily Volume (sh) 704,569 Shares Outstanding (mil) 101 Market Capitalization ($mil) $5,196 Short Interest Ratio (days) 1.56 Institutional Ownership (%) 88 Insider Ownership (%) 3 (AXS-NYSE) SUMMARY AXIS Capital s fourth-quarter earnings missed the Zacks Consensus Estimate and declined year over year. A soft interest rate environment weighed on investment results. Also, heightened competition, especially in Reinsurance, affected the bottom line. Nonetheless, strong underwriting results driven by low cat activity, favorable reserve development and a broadly diversified, well-constructed portfolio of risks were the positives. The company recently agreed to a merger with PartnerRe Ltd. Post-merger, the combined entity will be among the top-five global reinsurers in terms of premiums. Riding on its strong capital position, the board increased the quarterly dividend by 7%. The accident and health business continues to show strength. The Lloyd's unit continues to pave way for improvement while its third-party capital initiative, AXIS Ventures is expected to expand on its capabilities in its second year of operations. However, escalating expanses have been hurting the margins. Risk Level * Low, Type of Stock Large-Value Industry Ins-Prop&Caslty Zacks Industry Rank * 86 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $1.16 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 7.0 Earnings Per Share (%) 14.0 Dividend (%) 6.1 using TTM EPS 9.7 using 2015 Estimate 11.4 using 2016 Estimate 11.0 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page ,028 A 1,046 A 1,045 A 1,078 A 4,196 A ,042 A 1,117 A 1,118 A 1,036 A 4,347 A ,051 E 1,066 E 1,081 E 1,090 E 4,288 E ,430 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 $2.21 A $0.43 A $1.74 A $1.41 A $5.49 A 2014 $1.24 A $1.63 A $1.27 A $1.18 A $5.32 A 2015 $1.15 E $1.25 E $0.87 E $1.25 E $4.52 E 2016 $4.69 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved North Canal Street, Chicago IL 60606

2 OVERVIEW Incorporated in Nov 2001, AXIS Capital was one of the several insurance carriers formed to take advantage of the enhanced insurance demand following the 9/11 terrorist attacks. Bermuda-based AXIS Capital is a global provider of specialty lines insurance and treaty reinsurance. The company operates in Bermuda, the U.S., Singapore, and Europe. The company was listed on the NYSE in Jul AXIS Capital has two reportable segments: The Insurance segment offers a diverse portfolio of primary and excess products, ranging from property, marine, energy and casualty insurance to professional lines, aviation, terrorism, credit and political risk, customized insurance programs with managing general agency (MGA) partners and other specialized coverage. The Reinsurance segment provides property and casualty treaty reinsurance to insurance companies predominantly on an excess-of-loss basis. Since inception, this segment has been a reinsurer of natural and man-made catastrophe exposures as well as traditional property business, professional lines, liability, motor, credit/bond and other specialty risks globally. On Jan 27, 2015, AXIS Capital and PartnerRe Ltd. entered into a merger agreement. The deal is expected to culminate by the second half of 2015, once the regulatory and shareholder approvals are attained. REASONS TO BUY Given the intensely competitive environment that the reinsurance industry is facing amid declining premiums, AXIS Capital and PartnerRe Ltd. announced their stock swap merger agreement to guard against future losses and reserve shortfalls. The merged entity is presently worth about $11 billion. Post amalgamation, the new entity would have gross premiums of over $10 billion, an investment portfolio of over $33 billion and total capital of more than $14 billion, along with a $2.5 billion worth of underwriting business. AXIS estimates its global specialty insurance business to benefit immediately from additional revenues and expanded geographic distribution. These figures suggest that the PartnerRe-AXIS fusion will be ranked as one of the top-five global reinsurers in terms of premiums. This would give it a huge competitive advantage. PartnerRe and AXIS expect pre-tax cost synergies worth $200 million from the merger within the first 1.5 years only, with accretion to earnings as well as on return on equity (ROE), New business opportunities across AXIS Capital s lines of business and geography have helped the company achieve growth in premium writings. The Insurance segment in particular, continues to drive solid numbers. Consolidated net earned premium increased 12.5% in 2011, 3% in 2012, 8.5% in 2013 and 4.4% in While insurance premium benefitted from expansion in the accident and health lines, growth in liability lines and the positive impact of the reductions in the professional and liability ceded reinsurance programs implemented in 2013, the reinsurance segment benefitted from growth in liability and motor lines, continued expansion of the agriculture business and an increase in professional lines. AXIS Capital has also been benefiting from rate increases that finally leveled off but will continue to benefit from solid fundamentals and growth opportunities. AXIS Capital s new syndicate at Lloyds, Axa syndicate 1686, continues to perform well. The company has also started to weigh the opportunities for AXIS Ventures, the new third-party capital initiative. In addition, its initiatives including re-entry into U.S. primary casualty, and weather and commodities business is contributing to results. The company expects to capitalize on the new opportunities provided by its Equity Research AXS Page 2

3 global licenses and widespread distribution network. Management also expects gross premiums written in 2015 to improve from the 2014 level. Riding on the back of increasing premiums, top line grew 7% in 2011, 3.3% in 2012, 6.9% in 2013 and 3.6% in This top-line momentum is expected to be sustained on the back of new strategic changes made by the company across its reinsurance, purchasing and insurance segment. For example, a decrease in quota share session rates in professional lines and liability books and cost minimization of AXIS Capital s property for risk and property cat-protections are expected to drive up revenues for the company. AXIS Capital continues to boost its shareholder value through share buybacks and dividend hikes. The company has been continually increasing dividends each year. The approval of a 7.4% dividend hike in Dec 2014 marked the 11 th consecutive year of payout increase. The company increased dividend at an 11-year CAGR of about 14%. The dividend of $0.29 per share currently yields 2.26%, which is better than the sector yield of 1.75%. With respect to share buybacks, the company spent $543 million on buying back 11.8 million shares in Moreover, in Dec 2014, the board of directors of AXIS Capital approved a new share repurchase authorization of $750 million that is due to expire at the end of 2016 but suspended the same till the closure of the merger with PartnerRe. The company has returned about $661 million in 2014 to its shareholders in the form of dividends and buybacks, representing 117% of operating income. We believe a strong cash balance and retained earnings as well as solid bottom line growth owing to better performances across the segments will continue to support AXIS Capital s share buyback activities and dividend payouts. The company envisions returning near about 100% of annual operating earnings to through dividends and share repurchases. AXIS Capital has witnessed a U -shaped investment income trend for the last few years. The downward trend commenced with 12.4% decline in 2010 and a further 10.9% in The trend changed its course with net investment income improving 5.1% in 2012 and again 7.4% during 2013 to $409.3 million. The increase was mainly due to rise in other investment income, which in turn resulted from the company s higher investments in hedge funds. However, 2014 witnessed a 16% decline in net investment income due to lower returns from hedge funds and reflected lower returns from the global equity markets during Nonetheless, we expect the investment portfolio to perform strongly despite the prevailing soft interest rate environment. REASONS TO SELL AXIS Capital is highly exposed to losses resulting from natural disasters, man-made catastrophes and other catastrophic events. The severe and frequent occurrence of such events caused an underwriting loss of $327.2 million for the company in 2011 compared with $409 million of underwriting income reported in witnessed underwriting income of approximately $263 million. Underwriting income during 2013 inched down nearly 1.2% but improved 19.7% in 2014 on low cat activity, favorable reserve development and a well-managed portfolio of risks. Combined ratio deteriorated 940 basis points (bps) to 88.7% in 2010 and 2,360 bps to 112.3% in However, the same improved 1,610 bps to 96.2% in 2012 and 520 bps to 91% in 2013 but deteriorated 60 bps to 91.6% in Exposure to catastrophe activities will always remain a concern because of the uncertainty of occurrence as well as the magnitude of impact. We believe that increasing competition in the insurance industry can result in slow growth and lower profitability for AXIS Capital. The company competes with international and regional peers that are based in the U.S., Europe, Bermuda and other locations, as well as with new entrants to the industry. Some of these peers have greater marketing, financial and management resources than AXIS Equity Research AXS Page 3

4 Capital. We also believe that recent alternative products issued by capital market participants to replace reinsurance products can result in lower submissions, weak premium rates, higher costs of customer acquisition and retention, and less favorable terms and conditions of policies for the company. Also, operational results are subject to the risk of currency fluctuations. AXIS Capital has been witnessing rising expenses over the last few years. Total expense of the company increased 16.7% year over year in 2010 and 40.8% in Although 2012 exhibited a slight improvement in the expense level, it again increased 2.5% year over year in 2013 and 1.6% in The increase was primarily due to higher net losses and loss expenses, general and administrative expenses, higher acquisition costs and increase in interest expense and financing costs. This gradual increase in the expense level is affecting the operating margin expansion of the company. Higher expenses have been eating into the margin, which eroded from 25.2% in 2010 to 19.1% in If expenses continue to increase and the magnitude of rise in revenues fails to exceed the magnitude of increase in expenses, operation margin expansion will be affected. AXIS Capital derives a large portion of its revenues from a limited number of brokers. About 56% of gross premiums written in 2014 came from Marsh & McLennan Companies, Inc., including its subsidiary Guy Carpenter & Company, Inc., Aon Corporation and Willis Group Holdings Ltd. Failure to maintain underwriting and claim services quality, deterioration in financial strength ratings or brokers buying stakes in insurance and reinsurance companies and hence competing directly with AXIS might result in loss of business from these brokers. This in turn will weigh on the top line of the company. RECENT NEWS AXIS Capital Declares Dividend Feb 20, 2015 The board of directors of AXIS Capital declared a quarterly dividend of $0.29 per share. The dividend is payable on Apr 15, 2015 to the shareholders of record at the close of business on Mar 31. AXIS Capital Q4 Earnings Miss on Soft Investment Results Feb 3, 2015 AXIS Capital Holdings Limited s fourth-quarter 2014 earnings per share of $1.18 missed the Zacks Consensus Estimate by a couple of cents. Earnings declined 16% year over year. A soft interest rate environment weighed on investment results. Also, heightened competition, especially in Reinsurance, affected the bottom line. Nonetheless, strong underwriting results driven by low cat activity, favorable reserve development and a broadly diversified, well-constructed portfolio of risks were the breathers. Including net realized investment loss of $0.01 per share and foreign exchange loss of $0.43 per share, AXIS Capital reported net income of $1.60 per share, up 5.3% year over year. Operational Update A 31% year-over-year drop in net investment income overshadowed a 1.8% rise in premiums earned, resulting in a 51% drop in total revenue. Revenues of $1.04 billion also missed the Zacks Consensus Estimate of $1.06 billion. Total expense in the quarter decreased about 5.8% year over year to $48 million. Equity Research AXS Page 4

5 Underwriting income of AXIS Capital increased 20% year over year to $112.7 million. Combined ratio improved 100 basis points (bps) to 91.5%. Full-Year 2014 Review AXIS Capital s operating income of $5.32 per share missed the Zacks Consensus Estimate by 0.4% and declined 3% over Net income came in at $7.29, up 23% over Revenues improved 2.3% year over year to $4.2 billion. Segment Result Insurance Segment: Gross premiums written increased 3% year over year driven by better performing property lines, and liability lines fueled by growing U.S. excess casualty markets. Net premiums earned increased about 3% year over year owing to improvement in accident and health business lines. Underwriting income increased more than threefold to $34 million. Combined ratio improved 510 bps year over year to 92.7%. Reinsurance Segment: Gross premiums written in the quarter decreased 7% year over year to $138 million, largely due to soft performing professional and property lines. Net premiums earned increased 2.8% year over year. While underwriting income decreased 6%, combined ratio improved 170 bps year over year. Financial Update AXIS Capital exited the quarter with cash and cash equivalents of $1.3 billion, up 22% from the 2013-end level. Total capitalization at quarter end was $6.8 billion, including $1 billion of long-term debt and $0.6 billion of preferred equity. The company repaid $500 million of 5.75% senior unsecured notes. Cash flows from operations of $887 million decreased 19.4% year over year. Book value per share was $50.63 on Dec 31, 2014, up 11% year over year. Capital Deployment During the reported quarter, AXIS Capital repurchased 1.5 million shares for $75 million taking the full year tally to 11.8 million shares bought back for $543 million. The board increased the quarterly dividend by 7% to $0.29 per share. AXIS Capital-PartnerRe Ink Merger Deal Jan 27, 2015 PartnerRe Ltd. and AXIS Capital announced their intention to join in a stock swap merger agreement. The deal is expected to culminate by the second half of Equity Research AXS Page 5

6 AXIS shareholders will receive one share of the merged company against each existing share, while PartnerRe investors will own 2.18 shares of the new entity for each of its present share. Accordingly, the swap will give PartnerRe a 51.6% stake in the merged company, whereas AXIS will have the remaining 48.4%. The merged entity is presently worth about $11 billion. Moreover, post amalgamation, the new entity would have gross premiums of over $10 billion, an investment portfolio of over $33 billion and total capital of more than $14 billion, along with a $2.5 billion worth of underwriting business. These figures estimate the combined PartnerRe-AXIS to be among the top-five global reinsurers in terms of premiums. PartnerRe and AXIS expect pre-tax cost synergies worth $200 million from the merger within the first 1.5 years only. Equity Research AXS Page 6

7 VALUATION AXIS Capital shares currently trade at 11.4x our 2015 earnings estimate, a 25% discount to the industry average of 15.2x. On a price-to-book basis, the shares are trading at 1.0x, a 23.1% discount to the industry average of 1.3x. The valuation on a price-to-book basis looks attractive, given the trailing 12- month ROE of 11.0% substantially higher than the industry average of 9.3%. Our six-month target price of $54.00 equates to 11.9x our earnings estimate for Combined with the annual dividend of $1.16, this price target implies an expected total return of 6.1% over that period. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low AXIS Capital Holdings Ltd. (AXS) Industry Average S&P First American Financial Corporation (FAF) Cincinnati Financial Corp. (CINF) NA AmTrust Financial Services, Inc. (AFSI) Arch Capital Group Ltd. (ACGL) 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 AXIS Capital Holdings Ltd. (AXS) Industry Average S&P Equity Research AXS Page 7

8 Earnings Surprise and Estimate Revision History Equity Research AXS Page 8

9 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of AXS. 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 1133 companies covered: Outperform %, Neutral %, Underperform 8.8%. 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. Equity Research AXS Page 9