Allstate Shares Deserve a Better Premium

INSURANCE-GIANT ALLSTATE has endured scores of profit-shredding natural calamities over its more than seven decades of existence -- from Hurricanes like Katrina to California's Northridge earthquake. Yet none of these events has proven as devastating to Allstate's (ALL) financials as the tsunami that hit the global financial markets over the past year.

To wit, heavy asset write-downs in Allstate's now $94 billion investment portfolio were largely responsible for the company's posting a loss of $1.7 billion for 2008 and of $274 million in this year's first quarter. This compares to lush profits of $4.6 billion, or $7.83 a share, and $5 billion, or $7.89 a share, in '07 and '06, respectively.

Even worse was the damage wrought by the credit crisis on Allstate's shareholder net worth, or book value. Largely as a result of realized and unrealized security losses, its equity per share has plummeted between year-end 2007 and first-quarter '09 by more than 40% -- from $21.9 billion, or $38.58 a share, to $12.24 billion, or $22.65 a share. As a result, Allstate stock (ticker: ALL) has been pummeled, falling from nearly 60 in the fourth quarter of 2007 to a low of under 14 in March, before recently rebounding to around 25. Red ink hasn't been the stock's only problem. The company has also slashed the quarterly dividend rate in half and suspend a $2 billion stock-buyback program in midstream in order to marshal precious capital.

Yet barring some huge natural disaster, Allstate appears unimpeachably to be on the mend. Perhaps most important, the company has belatedly cut back on the risk in the $59 billion portion of its investment portfolio that backs its life insurance and other financial-products operations. This has been achieved by shortening the duration of its bond portfolio to render it less sensitive to changes in interest rates and by shifting some investments from more risky sectors like commercial real estate to tamer asset classes like money markets.

Moreover, Allstate is beginning to cut back on its life and financial products to emphasize what it calls its "protection" business -- auto and homeowners' policies, which are carried by some 70 million Americans. This makes eminent sense, since Allstate's property-and-casualty business traditionally has earned a return on equity approaching 15%, and, in the financial unit's best years, still accounts for 80% or more of the company's earnings.

"Life insurance in most years has been a nice add-on business, and we plan on staying in the financial-products area on a reduced basis," Allstate Vice President and Chief Financial Officer Don Civgin asserted to Barron's. "But it makes sense for us to build on what we're really good at and delivers most of the earnings -- our protection business."

The great fear this spring was that Allstate would be forced to drastically dilute its stock to boost its capital. It wasn't an errant concern after the company had seen more than 40% of its book value go up in smoke. But these concerns have dissipated since as some of its bond holdings have improved in price, and Allstate says it has sufficient wherewithal to conduct its insurance operations. Last month, Allstate even turned down a capital infusion proffered by the Troubled Asset Relief Program.

STILL, ALLSTATE ISN'T ABOVE a bit of old-fashioned embellishment in depicting its capital position. In recent weeks, it has ballyhooed the fact that its casualty-insurance unit (auto and homeowners) has $13 billion in so-called statutory, or regulatory, capital, and its life-insurance unit has $3.4 billion in stat capital.

That sounds like a nice cushion over the $12.24 billion in capital reported on Allstate's GAAP (generally accepted accounting principles-based) balance sheet. Yet the actual stat number should be reported as $13 billion for the two companies combined, since the $3.4 billion number is, in effect, being counted twice. That's because the casualty company owns the life-insurance unit, and as a result of the stacking, commingles the unit's capital with its own. Yet Allstate stock, even at current levels in the mid-20s, seems cheap.

It will surely take awhile for Allstate to recover its earnings power of just two years ago. Yet analysts' consensus earnings forecasts (earnings before any special items such as capital gains and losses) sit at $3.91 a share for this year, and $4.24 a share for 2010. Hence at 25, the shares trade for less than six times next year's number. That's rock-bottom in just about anybody's book. A climb in Allstate book value back to its old high of $21.9 billion, or $38.58 a share, seems some years away. Still, Credit Suisse analyst Vinay Misquith foresees book value rising to nearly 28 a share by the end of next year, from its March 31 level of 22.65 a share.

ALLSTATE CERTAINLY DESERVES to sell at a price-to-book ratio of well above one-times, given its status as the largest publicly-owned personal-lines insurer in the U.S.

"Allstate is an interesting opportunity, because I believe it was unfairly tarred with the woes of the life-insurance industry, with investors ignoring its highly profitable primary business in auto and homeowners," explains Misquith. "The company has a huge market share in personal-auto insurance, and that business is fairly sticky, despite the long-term secular inroads direct writers like Progressive and Geico are making, because the latter don't have to compensate agents as Allstate does." Misquith has a 12-month price target of 32 on the stock. Analyst William Yankus of Fox-Pitt Kelton has an even higher target of 40 a share.