March 17, 2015 XL Group plc (XL-NYSE) NEUTRAL Current Recommendation Prior Recommendation Outperform Date of Last Change 08/22/2013 Current Price (03/16/15) $36.78 Target Price $39.00 SUMMARY XL Group s fourth-quarter operating net income was above the Zacks Consensus Estimate and year-ago quarter figure. The outperformance came largely on the back of solid underwriting owing to a quiet catastrophic environment. The underwriting results were one of the best with underwriting profit improving more than 50% and combined ratio being the strongest in more than 15 years. Net investment income continues to decline yet XL Group aims a premier position in global specialty insurance and reinsurance markets and hence inked a deal to buy Catlin Group. Earlier, XL Insurance (Bermuda) divested XL Life Reinsurance expecting improvement in the risk profile and flexibility to pursue capital management initiatives. Also, XL Group always remains focused to tap opportunities in emerging economies. However, exposure to cat losses always remains a concern. Moreover, with $3.0 billion worth of P&C assets, with an average gross book yield of 3%, is expected to mature and pay down over the upcoming 12 months will pressurize net investment income. SUMMARY DATA 52-Week High $36.78 52-Week Low $29.92 One-Year Return (%) 24.46 Beta 1.15 Average Daily Volume (sh) 2,965,121 Shares Outstanding (mil) 255 Market Capitalization ($mil) $9,379 Short Interest Ratio (days) 4.31 Institutional Ownership (%) 93 Insider Ownership (%) 2 Risk Level * Low, Type of Stock Large-Value Industry Ins-Prop&Caslty Zacks Industry Rank * 65 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) Annual Cash Dividend $0.64 Dividend Yield (%) 1.74 5-Yr. Historical Growth Rates Sales (%) 4.3 Earnings Per Share (%) 16.5 Dividend (%) 12.0 using TTM EPS 10.0 using 2015 Estimate 11.7 using 2016 Estimate 10.4 2013 1,776 A 1,806 A 1,878 A 1,833 A 7,541 A 2014 1,722 A 1,710 A 1,643 A 1,620 A 6,976 A 2015 1,461 E 1,485 E 2,435 E 2,016 E 7,397 E 2016 9,046 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 $0.93 A $0.75 A $0.53 A $1.00 A $3.23 A 2014 $0.85 A $1.02 A $0.70 A $1.12 A $3.68 A 2015 $0.71 E $0.85 E $0.62 E $0.96 E $3.14 E 2016 $3.52 E Zacks Rank *: Short Term 1 3 months outlook 3 - Hold Projected EPS Growth - Next 5 Years % 9 * Definition / Disclosure on last page 2015 Zacks Investment Research, All Rights reserved. www.zacks.com 111 North Canal Street, Chicago IL 60606
OVERVIEW Upon its redomestication to Ireland from the Cayman Islands, on Jul 1, 2010, the company changed its name to XL Group Plc. (XL) from XL Capital Ltd. Founded in 1986; the company has grown through several mergers and acquisitions to become a leading global provider of insurance, reinsurance and financial risk solutions for enterprises and insurance companies. The Bermuda-based company s insurance products provide customized coverage for corporate risks and are divided into two categories: risk management products (global property and casualty programs for large multinational corporations) and specialty lines products (a wide variety of liability products, including professional, workers comp, environmental, and property coverage for marine, aviation and satellite equipment). Much of the company s casualty business is written on an umbrella or high-layer excess-of-loss basis. The excess nature of many of the company s insurance products, coupled with historically large policy, limits creates a sizeable book of business that can be classified as low frequency and high severity. The company is organized into three operating segments: Insurance, Reinsurance and Life Operations: The Insurance segment provides commercial property, casualty and specialty insurance products on a global basis. The Reinsurance segment provides casualty, property risk (including energy and engineering), property catastrophe, marine, aviation and other specialty reinsurance on a global basis. The Life Operations segment provides life reinsurance on business written by life insurance companies, principally to help them manage mortality, morbidity, survivorship, investment and lapse risks. REASONS TO BUY XL Group remains focused on its insurance and reinsurance business lines that provide the best return on capital over the pricing cycle. To refine its business mix, XL Group is deploying capital in businesses with lower loss ratios resulting in margin expansion. The company will be discerning new businesses, emphasizing short-tail lines wherever available in its reinsurance operations, exit other businesses like casualty facultative, not renew certain insurance programs, and continue to reduce long-term agreements (within the insurance operations) in order to reap the benefits of improved pricing. Eyeing the premier spot in global specialty insurance and reinsurance markets, XL Group inked a deal in January, to buy Catlin Group Limited. The acquisition will also increase alternative capital opportunities. Moreover, XL Group will significantly increase its business in the Lloyd's platform, where Catlin boasts a leading presence. Also, the transaction will straightaway expand quite a few lines of business of XL Group in which it has lately made investments. In addition, to improve the risk profile and gain additional flexibility to pursue capital management initiatives, XL Insurance (Bermuda) Ltd. divested its wholly owned subsidiary, XL Life Reinsurance (SAC) Ltd ( XLLR ), to GreyCastle Holdings Ltd. for $570 million in cash last May. Life Reinsurance was vended so that the company could increase focus on its property and casualty business. With strong international exposure and diversified product offerings, we believe that the company is well positioned to write higher premiums to drive top-line growth, going forward. XL Group is also aiming to tap opportunities in the growing economy. In Oct 2010, XL Group s subsidiary, XL Insurance Company Limited, received the license from the Malaysian Federal Territory of Labuan to underwrite Property, Construction, Energy, Casualty, Specialty and Professional lines insurance business in and through the Labuan insurance market. The same year, it inked a deal with Breed's Hill Insurance Agency, Inc. for General Liability and Property coverage Equity Research XL Page 2
for multi-unit apartment buildings, condominium associations and mixed-use real estate risks mainly in the New England market. In May 2011, XL Insurance joined forces with Keith D. Peterson & Company to provide comprehensive insurance coverage to the forest products industry. In Aug 2011, XL Insurance's Design Professional group agreed to offer physical damage insurance coverage for dealerships nationwide. The company also teamed up with Hays Affinity Solutions, a division of Hays Companies of Minneapolis in Feb 2012 to offer professional liability insurance to dentists. XL Group has also received the final approval to establish a Brazilian insurance operation. The company offers Casualty, Property, Professional and Specialty insurance products through XL Seguros Brasil S.A., thereby launching its insurance operations in that country. With Brazil continuing to play an important part in the global economy, we expect XL Group to capitalize on opportunities in that country. Moreover, to expand its business further, XL is expanding its coverage to upper and middle market businesses in North America. It also formed a new unit within XL s International Reinsurance business group. The new unit is intended to consolidate the operations of the company so that it can cater to clients in a better manner. A subsidiary, XL Reinsurance America Inc. acquired crop insurance provider, Global Ag Insurance Services to capitalize on the expertise of Global Ag in western U.S.A. XL Group continues to enhance shareholders value through dividend payment as well as share repurchase. In Feb 2014, the board of directors approved a share repurchase program wherein the company was authorized to buy back up to $1 billion worth of shares. The buyback covered approximately $200 million worth of shares available for repurchase under the $850 million share buyback program approved in Feb 2013. Share buybacks in 2014 totaled $800 million and the company is left with $267.6 million under its authorization. The board also approved a 14% hike in Feb 2014. Its dividend yield is currently 1.79%, better than the sector average of 1.75%. This reflects a strong balance sheet and healthy free cash flow. Additionally, these endeavors retain investors confidence in the stock. With a strong balance sheet (with the repayment of 5.25% senior notes worth $600 million, the company s debt-to-capital ratio improved by 390 basis points at 2014 end) and its ability to generate healthy cash flow, we expect the company to indulge in more buybacks going forward, thereby sharing more profits with shareholders. REASONS TO SELL XL has substantial exposure to losses resulting from natural and man-made disasters and other catastrophic events. The entire industry benefited from lower cat loss in the first quarter of 2013. Underwriting profit declined 28.8% year over year in the second quarter with combined ratio deteriorating 300 basis points (bps). The third quarter also bore the brunt of CAT activities. Underwriting profit declined 32.7% year over year with combined ratio deteriorating 280 bps due to a series of hailstorms in Germany, Hurricane Ingrid in Mexico and flooding in Colorado and Toronto. However, due to a benign CAT environment, the fourth quarter recorded an underwriting profit, rebounding from the year-ago loss, along with an improvement in combined ratio. First-quarter 2014 again witnessed a decline in underwriting profit as well as deterioration in combined ratio. However, the remaining three quarters of 2014 benefited from favorable CAT environment. Underwriting income in 2014 improved 50% with combined ratio improving 430 basis points. Exposure to catastrophic events will always remain a concern owing to their uncertainty and the magnitude of impact. Net investment income at XL Group has been declining over the past few years, and 2014 was no exception. It declined 23% over a 4-year period. It also experienced lower investment yields due to lower reinvestment rates. With performance closely linked to credit markets, which remain volatile, the exposure to these assets can further cause volatility in investment earnings. Therefore, any loss emanating from the investment portfolio will depress the book value. Management expects net investment income to remain constrained due to the persistent low interest rate environment. Also, Equity Research XL Page 3
$3.0 billion worth of P&C assets with an average gross book yield of 3% is expected to mature and pay down over the upcoming 12 months. This is also expected to put pressure on net investment income. XL s operating expenses have been rising over the last few years. It increased 11.4% year over year in 2011, 8.3% in 2012, 3.3% in 2013 and 10.6% in 2014. Increased operating expense is also restrict operating margin expansion. Additionally, the company s cash provided by operating activities has been fluctuating over the past few years. Cash used in operating activities was $42.7 million in 2009. In 2010, cash inflow from operating activities of $594 million showed year-over-year improvement but declined to $327 million in 2011. In 2012, it again increased to $1.1 billion just to report yet another decline of 26% in 2013. Last year, cash flow from operations increased 24%. The fluctuating cash position of the company makes us cautious about its ability to meet debt and liquidity needs as well as working capital requirements. RECENT NEWS XL Group Announces Quarterly Dividend Feb 20, 2015 On Feb 19, the board of directors of XL Group declared a quarterly dividend of $0.16 per share payable. The dividend will be payable on Mar 31, 2015 to the shareholders of record as of Mar 13. XL Group and RPS/Plus Companies Expand Partnership Feb 9, 2015 XL Group and RPS/Plus Companies expanded their underwriting partnership to bring professional liability insurance under title & escrow agents. With limits of liability up to $5 million per claim and a $5 million annual aggregate, the XL Group/Plus Companies professional liability program is designed for US-based title agents, title abstractor, closing agent, escrow agent, or notaries with revenues up to $10 million. Coverage is underwritten by the Plus Companies' specialized professional liability underwriters and provided by the XL Group of insurance companies. XL Group Q4 Earnings Beat on Solid Segmental Performance Feb 2, 2015 XL Group plc reported fourth-quarter 2014 operating net income of $1.12 per share, which beat the Zacks Consensus Estimate by 27%. Earnings improved 12% year over year and marked five straight quarters of positive earnings surprise. The outperformance came largely on the back of solid underwriting results in both segments and Reinsurance owing to a quite catastrophic environment. Insurance Including non-recurring items, the property and casualty insurer reported net income of $0.53 per share, which dropped 50% year over year. Quarterly Operational Performance Total revenue of XL Group was $1.66 billion, which declined 13% year over year. Revenues managed to surpass the Zacks Consensus Estimate of $1.54 billion. Net premiums earned decreased nearly 9.8% year over year to $1.44 billion. Net investment income of $226.2 million was down 6.1% year over year. Equity Research XL Page 4
XL Group s underwriting profit more than doubled to $219 million. The combined ratio in the quarter improved 880 basis points to 84.5%. Pre-tax cat losses, net of reinsurance and reinstatement premiums, came in at $31.7 million, much lower than $94.3 million in the year-ago quarter. Total expense of XL Group decreased about 21% year over year to $1.29 billion attributable to lower net losses and loss expenses incurred on P&C operations, claims and policy benefits, acquisition costs and interest expense. P&C Operations: Gross premiums written in the quarter increased 11.2% year over year. The upside was attributable to a 13.1% improvement in Insurance premium, partially offset by 3.6% lower Reinsurance premium. Solid new business particularly in International Financial Lines, Construction, North America Primary Casualty, Marine and Political Risk, and solid premium retention across most of the portfolio drove the upside in Insurance. Though non-renewal activity in the US Casualty Treaty book and foreign exchange were responsible for lower Reinsurance premium, growth in International Casualty Treaty, Property Facultative, US Property Treaty and Crop compensated partially. Combined ratio (excluding prior-year development and the impact of natural catastrophe losses) improved 190 bps to 89.1%. Full-Year Review XL Group posted operating income of $3.68 which outperformed the Zacks Consensus Estimate by 6.4% and improved 14% year over year. Net income slumped to $0.69 per share from $3.63 earned in the year-ago quarter. Revenues declined 7.5% year over year to $6.97 billion. While underwriting profit increased 50%, combined ratio improved 430 basis points to 88.2% Financial Update XL Group exited 2014 with cash and cash equivalents of $2.52 billion, up 40% from $1.80 billion at the end of 2013. Notes payable and debt at quarter end were $1.7 billion, lower than the 2013-end level of $2.3 billion. Book value of XL Group as of Dec 31, 2014 was $38.51 per share, up 9% from $35.32 as of Dec 31, 2013. Share Repurchase Update In the reported quarter, XL Group spent $175 million on buying back 5.2 million shares, taking the fullyear tally to 24.7 million shares repurchased for $800 million. The company was left with $267.6 million under its authorization at Dec 31. Equity Research XL Page 5
VALUATION At the current price level, XL Group s shares trade at 11.7x our 2015 earnings estimate, a 66% discount to the industry average. Our six-month price target of $39.00 per share equates to about 12.4x our earnings estimate for 2015. Combined with the $0.64 per share annual dividend, this target price implies an expected total return of 6.9% over that period. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low XL GROUP PLC (XL) 11.7 10.4 9.0 7.7 10.0 80.0 5.9 Industry Average 15.0 13.5 9.0 12.9 17.2 67.7 8.3 S&P 500 16.3 15.2 10.7 14.5 17.9 18.4 12.0 Sampo Oyj (SAXPY) NA NA NA 13.7 14.6 14.9 9.2 Everesr RE Limited (RE) 9.3 8.9 6.9 6.7 7.2 23.0 6.7 W.R. Berkley Corporation (WRB) 14.3 13.2 9.0 11.2 14.0 17.3 9.7 PartnerRe Ltd. (PRE) 11.7 12.2 2.7 6.2 7.6 17.3 6.5 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 XL GROUP PLC (XL) 0.8 0.8 0.5 8.8 0.1 1.8 13.5 Industry Average 1.3 1.3 1.3 9.3 0.3 1.7 7.9 S&P 500 6.2 9.8 3.2 25.4 2.0 Equity Research XL Page 6
Earnings Surprise and Estimate Revision History Equity Research XL Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of XL. 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 - 15.5%, Neutral - 74.7%, 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 XL Page 8