February 06, 2015 Cincinnati Financial Corp. NEUTRAL Current Recommendation Prior Recommendation Outperform Date of Last Change 02/10/2014 Current Price (02/05/15) $51.89 Target Price $54.00 (CINF-NASDAQ) SUMMARY Cincinnati Financial reported fourth-quarter 2014 operating income that outperformed the Zacks Estimate Consensus and improved year over year. The quarter marked seven straight quarters of delivering investment income growth. We expect the company to benefit over the coming quarters from its numerous strategic growth initiatives and a gradually improving insurance market. Management is appointing agencies and expanding product offerings to compensate for the decline in business. However, a low interest rate environment and exposure to catastrophes are some of the headwinds. Nevertheless, low leverage, solid capital, consistent cash flow generation, favorable reserve release, share repurchases and consistent dividend increase are some of the other positives. We thus maintain our Neutral recommendation on the stock. SUMMARY DATA 52-Week High $52.54 52-Week Low $45.21 One-Year Return (%) 13.56 Beta 0.82 Average Daily Volume (sh) 580,939 Shares Outstanding (mil) 163 Market Capitalization ($mil) $8,458 Short Interest Ratio (days) 6.19 Institutional Ownership (%) 60 Insider Ownership (%) 10 Risk Level * Low, Type of Stock Large-Value Industry Ins-Prop&Caslty Zacks Industry Rank * 36 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $1.76 Dividend Yield (%) 3.39 5-Yr. Historical Growth Rates Sales (%) 4.8 Earnings Per Share (%) 21.9 Dividend (%) 2.4 using TTM EPS 19.5 using 2015 Estimate 19.9 using 2016 Estimate 20.1 2013 1,103 A 1,104 A 1,152 A 1,172 A 4,531 A 2014 1,189 A 1,214 A 1,280 A 1,230 A 4,945 A 2015 5,100 E 2016 5,370 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 $0.78 A $0.61 A $0.70 A $0.72 A $2.81 A 2014 $0.47 A $0.46 A $0.85 A $0.89 A $2.66 A 2015 $0.86 E $0.47 E $0.54 E $0.89 E $2.61 E 2016 $2.58 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606 N/A
RECENT NEWS Cincinnati 4Q Earnings Beat on Better Underwriting Results Feb 4, 2015 Cincinnati Financial Corp. reported fourth-quarter 2014 operating income of $0.89 per share, which surpassed the Zacks Estimate Consensus by 12.7%. Results were also up 24% year over year. Including $0.13 per of realized investment gains, net income of $1.02 per share in the quarter were up 38% year over year. Behind the Headlines Revenues in the reported quarter grossed $1.3 billion, up 8% year over year. The increase was driven by higher premiums earned (up 6%) and investment income (up 2%). Total benefits and expense of Cincinnati Financial increased 2.1% year over year to $1 billion, due to higher insurance losses and policy holder benefits along with underwriting, insurance and acquisition expense. Combined ratio a measure of underwriting profitability improved 350 basis points (bps) year over year to 90.4%. Cincinnati Financial had 1,466 agency relationships as of Dec 31, 2014, compared with 1,450 at the end of 2013. Full-Year Review Operating earnings of $2.66 per share outperformed the Zacks Consensus Estimate by 2.7%. Earnings however declined 5% from 2013. Net income of $3.18 per share improved 2% over 2013. Revenues improved 9% year over year to $4.9 billion. Quarterly Segment Update Commercial Lines Insurance: Total revenue of $731 million was up 7% year over year, led by an increase in premiums earned. Underwriting profit slid 4% year over year to $49 million, due to higher expenses. The combined ratio deteriorated 90 bps to 93.6% Personal Lines Insurance: Premium earned increased 7% year over year to $263 million owing to higher renewal written premiums that also fueled a 7% improvement in revenues. Underwriting profit came in at $43 million in the quarter while it broke even in the prior-year quarter. Combined ratio improved 1,660 bps to 83.7%, mainly due to lower catastrophe losses. Excess and Surplus Lines Insurance: The segment s earned premium of $39 million was up 26% year over year. Underwriting profit dropped 11% year over year to $8 million. The combined ratio saw a drastic 740 bps decline to 77.8% due to larger benefits from favorable prior accident year reserve development. Life Insurance: Premiums earned in the segment decreased 22% year over year to $51 million, primarily due to a 63% drop in Universal life insurance premiums. Total benefit and expense decreased 15% year over year to $74 million. Equity Research CINF Page 2
Financial Update As of Dec 31, 2014, Cincinnati Financial had assets worth $18.7 billion, up 6.2% from Dec 31, 2013. Cincinnati Financial s debt-to-capital ratio improved to 11.3% as of Dec 31, 2014 from 12.8% on Dec 31, 2013. As of Dec 31, 2014, book value per share of Cincinnati Financial was $40.14, up 7.9% year over year. VALUATION Cincinnati Financial s shares currently trade at 19.9x our earnings estimate for 2015, which is at a 35.4% premium to the industry average. On a price-to-book basis, the shares trade at 1.3x, at par with the industry average. The valuation on a price-to-book basis looks stretched, given that the trailing 12-month ROE, is significantly below of the industry average. Our six-month target price of $55.00 equates to about 20.7x our earnings estimate for 2015. We view the $1.76 per common share annual dividend as secure, implying an expected return of about 5.7% over that period. This is consistent with our Neutral recommendation on the shares. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Cincinnati Financial Corp. (CINF) 19.9 20.1 NA 16.8 19.5 53.3 14.5 Industry Average 14.7 13.5 8.9 12.2 14.9 66.0 8.1 S&P 500 16.3 15.2 10.7 15.0 18.8 19.4 12.0 The Hanover Insurance Group Inc. (THG) 12.3 10.9 NA 12.1 13.6 NA 11.3 Markel Corp. (MKL) 32.6 29.0 12.5 22.8 34.9 34.6 13.1 First American Financial (FAF) 15.2 14.4 12.4 9.8 19.5 19.0 6.9 AXIS Capital Holdings Limited (AXS) 11.2 10.6 8.5 7.0 9.7 114.1 6.2 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 Cincinnati Financial Corp. (CINF) 1.3 1.5 0.9 6.6 0.1 3.5 11.1 Industry Average 1.3 1.3 1.3 9.5 0.3 1.5 7.0 S&P 500 5.3 9.8 3.2 25.5 2.1 Equity Research CINF Page 3
Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research CINF Page 4
OVERVIEW The Cincinnati Financial Corporation, formed in 1968 with its headquarters in Fairfield, OH, markets property and casualty insurance as its main business. The company, founded almost 60 years ago by independent insurance agents, has an agent-centered business model which it believes, would enhance the ability of local independent insurance agents to deliver products to people. The company is among the top 25 property and casualty insurers in the U.S. It operates through four wholly owned subsidiaries The Cincinnati Insurance Company, CSU Producer Resources Inc., CFC Investment Company and CinFin Capital Management Company. The company presents its results through four separate operating segments: The Commercial Lines Property Casualty Insurance segment (accounted for 67% of total earned premiums in 2013) provides property and casualty insurance through seven commercial business lines Commercial casualty, Commercial property, Commercial auto, Workers compensation, Specialty packages, Surety and executive risk and Machinery and equipment. The Personal Lines Property Casualty Insurance segment (25%) functions through three separate lines of business Personal auto, Home owners and other personal lines. The Life Insurance segment (5%) offers insurance products through its subsidiary, the Cincinnati Life Insurance Company. Four lines of business within this segment Term insurance, Universal life insurance, Worksite products and Whole life insurance account for most part of the segment revenues. In addition, Cincinnati Life markets Disability income insurance, Deferred annuities and Immediate annuities. The Excess and Surplus segment (3%) covers small to mid-sized business risks with unique characteristics that are difficult to profitably insure in the standard commercial lines market. REASONS TO BUY Cincinnati Financial s Commercial Lines Insurance segment has been consistently witnessing topline growth for the past several quarters. This improvement has been due to several growth initiatives as well as a gradual increase in insurance rates. The company has implemented the use of predictive analytics to improve its pricing precision, while also leveraging local relationships with its agents. Moreover, the gradual improvement in pricing has contributed to the growth. We expect moderate top-line growth going forward, as competitive pressure will somewhat offset moderate price increases. Cincinnati Financial s Excess and Surplus line is also performing well. The segment has been generating underwriting income for the last eight quarters consecutively. Despite a soft market environment, the segment has been able to achieve rate increases for the last 41 months without fail, continuing at a low double-digit range. We expect the trend to continue, given the improving excess and surplus lines market. Appointing new agencies is one of the several strategic initiatives adopted by the company for 2014. Given Cincinnati Financial s agent-centered business model, its relationship with the local insurance agencies is a primary strategic advantage. The company appointed 75 new agencies in the first nine months of 2014, 96 in 2013 and 140 in 2012. In 2014, the company plans to appoint approximately 100 agencies. Those agencies, as well as others, appointed in recent years continue to present the company with opportunities to increase market share. The company is confident that its agentfocused business model will drive long-term premium growth just as it has for more than 60 years. Equity Research CINF Page 5
According to management, these new agencies will bring in $5.0 billion of direct written premium by 2015. Cincinnati Financial is focusing on increasing premiums through geographical diversification. Since 2007, it has entered the states of New Mexico, Washington, Texas, Colorado, Wyoming, Connecticut and Oregon. This has transformed the company s image from a regional insurer to a national insurer. This expansion is also an integral part of the company s long-term growth strategy. Cincinnati Financial s reliance on debt as a source of capital has been low. It targets a debt-to-totalcapital ratio of less than 20%. Moreover, its consistent cash flow and prudent cash balances continue to boost liquidity. In terms of capital management, Cincinnati Financial has returned capital to shareholders in the form of regular cash dividend. Management has also been consistently increasing the yearly dividend for the past 53 years. Moreover, the company also indulges in share repurchases from time to time. REASONS TO SELL Cincinnati expects higher catastrophe loss in 2014 relative to the benign 2013 cat season. Though the company has a diversified geographic profile, its business is significantly concentrated on the Midwest region, which is prone to catastrophes. As such, the company s operations have substantial catastrophe losses, which make its earnings volatile. The company s life insurance segment could be hurt by a still tepid U.S. economic recovery, adverse regulatory developments associated with Universal Life products with secondary guarantees and continued turmoil in group benefits associated with the Affordable Care Act. Investment income is an important component of Cincinnati Financial s revenues and net income. The company has experienced investment portfolio problems as a result of equity investments, which formed a significant portion of its portfolio. Though the portfolio has been diversified to reduce equity concentration, it still remains equity-heavy relative to its peers, thus imparting equity market related volatility. Moreover, low yield for investment options is expected to continue, thereby limiting investment income growth. DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of CINF. 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 1016 companies covered: Outperform - 15.1%, Neutral - 79.2%, Underperform 5.3%. 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 Equity Research CINF Page 6
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 CINF Page 7