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Lancashire Holdings Ltd

As long term readers of my twitter site know, Lancashire Holdings Ltd is a very interesting company based in the non-life insurance sector for Aviation, Energy, Marine Property and Terrorism which are highly profitable businesses.

The attraction is the continual bumper annual income of 9% mainly made up of a special dividend which is forecast to increase to 9.8% in 2015. Normally if a company pays over 7%, it’s distressed but Lancashire is a rare company paying these high amounts year after year since IPO. This is mainly due to the structure of the holding company and the nature of the non-life sector paying high income streams in good years. However Lancashire is exceptional due to its compounded annual growth over 5 years combined with reduced volatility makes it in my opinion best in its sector.

Market leading ratios show 27.6% over 5 years average including headcount and expenses which drive profitable growth way above the majority in the sector.

I think the company is significantly undervalued and at a discount to its sector at the present time for three reasons, firstly Lancashire bought Cathedral Capital giving it access to Lloyds of London to halt the declines of the general soft nature of the market at present. This led to most of the capital being used for M&A rather than distribution. However the share price reflects this and does not take into account the substantial special dividend being paid in December, well over 12 months since the takeover of Cathedral Capital with cash mounting up. So income investors should choose Lancashire as a number one company in the short term.

Secondly the continual payments over Costa Concordia were somewhat a drain on profits for the last couple of years, this is ending or significantly reducing, nobody expected a ship’s captain to run a ship onshore in good weather not within the normal shipping route pattern.

Thirdly interest rates are at historical lows resulting in reduced profit for this sector as cash held is invested into low interest or derivatives producing very low annual profit which used to be 40% of these business profit margin. However we all know interest rates will go up even at small amounts profit will grow substantially and the sector will once again be in fashion so a rerating is on the cards, it’s a question of when.  Furthermore it’s one of the only sectors that will benefit from an interest rate rise.

It’s easy to see why Neil Woodford of Woodford funds loves Lancashire, one of Britain’s leading fund managers over the long term and believes the futures bright based on management, risk approach, organic growth and increasing the dividends.

Looking at the business the Lloyds of London name was a very big movement forward last year apart from increased sales, costs going forward will reduce and the separate Kinsis fund producing fee income plus commission in an ever changing insurance world is an excellent addition created last year. So while others in the non-life are dying, Lancashire has positioned itself to get through the bear markets and back into growth phase.

Underwriting is still the biggest element of Lancashire combined with management strength taking a proactive approach, for example they take on the insurance post an earthquake or hurricane at very high rates and reduce reinsurance when the market area gets poor again. They do not just reinsure junk insurance every year for overall top line turnover on low profit which most of its competitors do. That’s why the company’s profit margins are very high when bad news happens, unlike the others who will be left hung out to dry.

I urge investors to see Lancashire Holdings operation breakdown on its website highlighted under presentations with more detailed figures. Highlighting the Bermudian connection with no stamp duty on purchasing shares adds to the dividend stream based on the FTSE index.

Since IPO in 2007, the company’s growth has seen +194%, this is exceptional performance considering the sector average performance and I would expect with the game changing events mentioned above to produce a strong performance both in income and growth over the long term, this stock will rerate even in this bear market.

Until the next time more ramblings from the castle can be seen @chrisoil

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