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Alleghany Corporation

Y: NYSE

Alleghany Corporation (Y) started as a railroad company almost ninety years ago and is now predominantly a reinsurer. It began its long transformation in 2001 with the acquisition of CapSpecialty and continued to acquire over the next fifteen years. The acquisition of Transatlantic Reinsurance Company (TransRe) in 2012 accelerated the company’s transformation and is now the dominant business. [1] Under the leadership of Weston Hicks, Alleghany has compounded book value per share at 8.5% per annum for fifteen years. [2]

Investment thesis

With 79% of capital in reinsurance, Alleghany is particularly vulnerable to large natural disasters. [3] With recent hurricanes Irma, Harvey and Maria, Alleghany’s stock has taken a hit, likely due to expectations of catastrophe losses. Historically, large CAT events have been followed by increases in insurance pricing. [4] We thought that the pullback may create a window of opportunity.

Confirmation through research

First we needed to figure out what the risk of losses could be at TransRe, Alleghany’s largest enterprise. We felt that TransRe’s partnership with Berkshire Hathaway’s Gen Re implied reasonable quality of underwriting supported by positive ratings by Moody’s and S&P. [5] Alleghany has significantly de-risked TransRe’s balance sheet since acquisition and it was recently upgraded by A.M. Best to A+ (Superior) Financial Strength. [6] Feeling comfortable with Alleghany’s ability to meet its reinsurance obligations and avoid major capital losses, we turned to industry pricing.

After talking with management and industry experts, we believe that the recent hurricanes’ estimated losses should be large enough to increase industry pricing. The CFO explained to us that TransRe’s losses would not actually be that material on an after-tax basis because the U.S. government absorbs a portion of the losses. In that case, any pricing should drop directly to the bottom line, driving earnings and return on equity (ROE) higher. We believe a double-digit ROE could reprice the stock to a higher multiple on top of higher earnings.

Variant Perception

With Insurance Insider also calling for an increase in pricing in its October issue, we felt assured that it was likely to come. [7] We thought that Alleghany might be underappreciated within the space with only three sell-side analysts covering it. Meeting management was key. Weston Hicks has been CEO for thirteen years and was previously CFO at Chubb and an insurance analyst at J.P. Morgan Securities and Sanford C. Bernstein & Co. before that. After visiting the company’s headquarters and meeting the team, we felt confident enough to make an investment.