March 18, 2015 Progressive Corp. Current Recommendation NEUTRAL Prior Recommendation Outperform Date of Last Change 05/19/2013 Current Price (03/17/15) $27.03 Target Price $28.00 SUMMARY DATA (PGR-NYSE) SUMMARY Progressive s earnings in the fourth quarter surpassed the Zacks Consensus Estimate. The fourth-quarter earnings as well as revenues improved year over year on higher premiums. Due to a favorable catastrophic environment, the combined ratio continues to show improvement. Policies in force remained healthy with both Personal Auto and Special Lines exhibiting an increase. To cater to customers opting for a combination of home and auto insurance, it will be acquiring the majority stake in ARX Holding. Its efforts to become a one-stop insurance shopping destination further raise optimism. However, going forward, its growth could be challenged owing to intensifying competition. Financial leverage also exhibited deterioration. 52-Week High $27.50 52-Week Low $23.22 One-Year Return (%) 16.83 Beta 0.74 Average Daily Volume (sh) 2,942,180 Shares Outstanding (mil) 589 Market Capitalization ($mil) $15,921 Short Interest Ratio (days) 4.24 Institutional Ownership (%) 76 Insider Ownership (%) 1 Annual Cash Dividend $0.69 Dividend Yield (%) 2.54 5-Yr. Historical Growth Rates Sales (%) 6.6 Earnings Per Share (%) 2.5 Dividend (%) 20.0 using TTM EPS 13.1 using 2015 Estimate 14.8 using 2016 Estimate 14.2 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page Risk Level * Low, Type of Stock Large-Blend Industry Ins-Prop&Caslty Zacks Industry Rank * 62 out of 267 ZACKS CONSENMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2013 4,357 A 4,459 A 4,422 A 4,465 A 18,171 A 2014 4,588 A 4,701 A 4,657 A 5,150 A 19,391 A 2015 4,823 E 4,986 E 5,063 E 5,219 E 20,091 E 2016 21,224 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 $0.42 A $0.40 A $0.36 A $0.42 A $1.59 A 2014 $0.41 A $0.60 A $0.46 A $0.60 A $2.06 A 2015 $0.45 E $0.47 E $0.43 E $0.47 E $1.82 E 2016 $1.91 E Projected EPS Growth - Next 5 Years % 9 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Based in Mayfield Village, OH, The Progressive Corporation (PGR) is one of the major auto insurers in the country. Founded in 1965, the company is a leading independent agency writer of private passenger auto coverage, and the market share leader for the motorcycle products since 1998. It is also one of the leading companies in the commercial auto insurance market. Progressive operates through two major business segments: The Personal Lines segment writes insurance for private passenger automobiles, recreational and other vehicles. This business generally offers more than one program in a single state, with each program targeted toward a specific distribution channel, market, or customer group. Personal Lines products comprise insurance for personal autos and special lines products. The Personal Lines business is either generated by independent agents and brokers or written directly online or by phone. The agency business includes business written by Progressive s network of more than 35,000 independent insurance agencies located throughout the United States, as well as brokerages in New York and California and strategic alliance business relationships (other insurance companies, financial institutions, and national agencies). The direct business includes business written directly by the company online and over the phone. The Commercial Auto segment writes primary liability and physical damage insurance for automobiles and trucks owned by small businesses. The majority of its Commercial Auto customers insure two or fewer vehicles. The Commercial Auto business, which is primarily distributed through the independent agency channel, operates in the business auto and specialty truck markets. The business auto market which accounts for one third of its total Commercial Auto premiums and approximately 60% of the vehicles Progressive insures in this business includes autos, vans, and pick-up trucks used by professionals such as contractors, landscapers and plumbers and a variety of other small businesses. The remainder is in the specialty truck commercial auto market, which includes dump trucks, logging trucks, tow trucks, local cartage and other short-haul commercial vehicles. Equity Research PGR Page 2
REASONS TO BUY Progressive is seen as a leader in product, service and distribution innovation, especially in personal auto. It is also a leader in underwriting technology and the application of quantitative analytics in pricing and risk selection. The company s rates are very competitive in all its markets and it continues to benefit from its expanded multi-product offering. Net premiums written continue to exhibit an upward trend. It increased at a five-year CAGR (2009 2014) of 5.90%. During 2014, the company wrote $2.6 billion premiums with customers who were a part of the Snapshot program. Business at Agency improved 3.8% in 2011, 3.1% in 2012, 6% in 2013 and 5% in 2014. At Direct Personal Lines, business improvement was 6.5% in 2011, 4% in 2012, 7.5% in 2013 and 11.5% in 2014. Commercial Auto business recorded growth of 4% in 2012 but a fall of 2% in 2013. However, results again improved 7% in 2014. Management continues to focus on customer retention. The policy life expectancy (PLE), a measure for customer retention, increased 6% both in 2011 and in 2012 for its Agency auto business. However, it declined 5% in 2013 and 2% in 2014. PLE for Direct auto businesses declined 6% in 2013. The decline, as expected, was solely due to rate increases undertaken by the company in 2012. As policies begin to renew within the same plan, the numbers are expected to improve, which was noticed in 2014 with an improvement of 3% in Direct auto businesses. The company has several initiatives underway aimed at providing consumers with distinctive new auto insurance options. The fastest personal auto growth area continues to be in Internet-produced business. Moreover, Progressive s Snapshot and Name Your Price programs are expected to drive growth. We expect the company to report a higher PLE in the coming quarters in light of the emphasis placed on competitive pricing for the current customers so as to ensure their retention. To return more value to shareholders, Progressive undertakes share buybacks, besides paying annual dividends. In Dec 2013, the Board approved a special dividend of $1.00, testifying the inherent strength of its balance sheet. Progressive has also been regularly paying annual cash dividends which increased at a three year CAGR (2012-2014) of 19%. With respect to share buybacks, it spent $273.4 million to repurchase 11.0 million shares in 2013 and $271.4 million to buyback 11.1 million shares in 2014. Of the share repurchase authorization worth 75 million shares approved in Jun 2011, the company is still left with 21.5 million shares to be bought back. Given its favorable financial strength, we expect more shares to be repurchased going forward. Additionally, over a period of five years the company s debt-to-capital ratio improved by 370 basis points to 23.8% in 2014. Going forward, we expect Progressive s deleveraging activities to further improve its debtto-capital ratio. Progressive has also been consistently putting in efforts to further penetrate the customer households through cross-selling auto policies and Progressive Home Advantage (PHA). PHA is a program where the company bundles its auto product with property insurance provided by unaffiliated insurance carriers. These bundled products form an integral part of the company s strategy to cater its customers opting for a combination of home and auto insurance. As of Dec 31, 2014, PHA was available to Direct customers in 49 states, Agency customers in 26 states (including three states added in 2014), and to both Direct and Agency customers in the District of Columbia. PHA was already available to Agency customers in Florida and, in 2014, was also made available to Direct customers in the state. However, PHA is not yet available to customers in Alaska. In the Direct channel, PHA is currently provided by 12 unaffiliated insurance carriers. In this respect, Progressive inked a deal to buy the majority stake in ARX Holding Corp., the parent company of American Strategic Insurance (ASI) and its affiliates. This acquisition, upon completion, is expected to reach the still under-penetrated market segment of bundled customers. Going forward, we expect Progressive to make further acquisitions, thereby enhancing its bundling strategy Equity Research PGR Page 3
REASONS TO SELL Although Progressive was effectively lowering its combined ratios (improved from 94.6% in 2008 to 91.6% in 2009), it gradually started reporting higher combined ratio. It deteriorated to 92.4% in 2010, to 93.0% in 2011 and further to 95.6% in 2012. However, the combined ratio improved 210 bps year over year to 93.5% in 2013 and by 120 bps to 92.3% in 2014. The improvement is attributable to the absence of any major catastrophe events during the quarter. A sustained improvement in the upcoming term is uncertain, given the sudden occurrences of catastrophic events. If any severe catastrophes occur in the near term, the combined ratio could further deteriorate. The combined ratio represents the percentage of premiums paid out as claims and expenses and is a primary measure of underwriting profitability. A higher combined ratio thus concerns the company s profitability. Continued growth at Commercial Auto businesses could be challenging. The soft economy, combined with heightened competition, has adversely affected this market. Depressed levels of employment, construction spending and new business creation, combined with constraints on commercial credit have led to a reduction in insurable risks, particularly for small businesses that are Progressive s primary customers. However, management believes that the Commercial Auto business is finally finding equilibrium with the market gradually improving. This could lead to a turnaround going forward. RECENT NEWS Progressive Keeps Surprise Streak Alive with Q4 Earnings Jan 28, 2015 Progressive Corp. s earnings per share for the fourth quarter of 2014 came in at $0.60 per share, 40% above the Zacks Consensus Estimate and up about 43% year over year. Including net realized gain, net income came in at $0.63 per share, improving 26% year over year. Progressive recorded net premiums written of $4.6 billion in the quarter under review, up 14% from $4.1 billion in the year-ago quarter. Net premiums earned were $4.9 billion, up 14% from $4.3 billion in the year-earlier quarter. Net realized gains on securities in the quarter were $26.2 million, down 66% from $77.0 million in the prior-year quarter. Combined ratio the percentage of premiums paid out as claims and expenses improved 290 bps from the comparable quarter a year ago to 90.9%. Numbers in December Progressive publishes monthly financial reports. In the month of Dec 2014, policies in force remained healthy, with the Personal Auto segment increasing 2% from Dec 2013 to 9.2 million. Special Lines increased 1% from Dec 2013 to 4 million. In Progressive's Personal Auto segment, Direct Auto grew 7% from Dec 2013 to 4.5 million. Agency Auto, however, decreased 2% from the Dec 2013 to 4.7 million. Progressive s Commercial Auto segment remained almost flat year over year at 0.5 million. Revenues of $1.8 billion improved 31% year over year on higher premiums. Total expense for the reported month increased 21% to $1.5 billion from $1.3 billion in Dec 2013. The major components contributing to the increase in total expense were a 27.5% increase in policy Equity Research PGR Page 4
acquisition costs, 19% higher losses and loss adjustment expenses; and a 27% rise in other underwriting expenses. Progressive reported book value per share of $11.79 on Dec 31, 2014, up from $10.39 as of Dec 31, 2013. Return on equity (ROE) on a trailing 12-month basis was 20.1% compared with 19% in Dec 2013, reflecting a 110 bps improvement. The debt-to-total capital ratio, however, deteriorated 70 bps year over year to 23.8% as of Dec 31, 2014. Dividend Update On Dec 19, 2014, the board of directors declared an annual dividend of $0.6862 per share or $404.1 million, to be paid on Feb 13, 2015 to shareholders on record as of Feb 4, 2015. Acquisition Last December, Progressive inked a deal to buy the majority stake in ARX Holding Corp., the parent company of American Strategic Insurance (ASI) and its affiliates, for a cash consideration $875 million. The transaction is expected to culminate by Apr 1, 2015. Equity Research PGR Page 5
VALUATION Progressive shares currently trade at 14.8x our 2015 earnings estimate, which is at 2.0% discount to the industry average of 15.1x. Our six-month target price of $28.00 equates to 15.4x our earnings estimate for 2015. Combined with $0.69 per share annual dividend this price target implies an expected total return of 4.9% over that period. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low PROGRESSIVE COR (PGR) 14.8 14.2 9.0 10.9 13.1 20.6 11.4 Industry Average 15.1 13.6 9.0 13.0 17.4 67.7 8.3 S&P 500 16.6 15.4 10.7 14.5 18.2 18.4 12.0 ACE Limited (ACE) 12.2 11.8 10.0 10.8 11.6 12.3 6.2 The Travelers Companies, Inc. (TRV) 11.4 11.2 7.7 4.3 10.3 19.1 7.7 The Chubb Corporation (CB) 13.3 13.3 6.3 11.2 13.3 16.1 8.6 CNA Financial Corporation (CNA) 12.2 11.8 7.5 12.0 12.7 16.6 7.3 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 PROGRESSIVE COR (PGR) 2.3 2.6 1.9 18.2 0.3 2.6 7.0 Industry Average 1.3 1.3 1.3 9.3 0.3 1.7 8.0 S&P 500 6.2 9.8 3.2 25.4 N/A 2.0 N/A Equity Research PGR Page 6
Earnings Surprise and Estimate Revision History Equity Research PGR Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of PGR. 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 1130 companies covered: Outperform - 15.1%, Neutral - 75.0%, Underperform 9.0%. 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 PGR Page 8