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Arch Capital Plunges 25% YTD: What's Behind the Decline?

Zacks Equity Research

Arch Capital Group Ltd. ACGL has been suffering from escalating costs and weak underwriting results. These, in turn, have been putting pressure on margin expansion.

Shares of this Zacks Rank #5 (Strong Sell) property and casualty (P&C) insurer have lost 24.5% on a year-to-date basis compared with the industry’s decline of 18.3%.

 

 

The Zacks Consensus Estimate for 2020 earnings is pegged at 86 cents, indicating a decline of 69.5% from the year-ago reported figure. The stock has also seen the Zacks Consensus Estimate for current-year earnings being revised 60.2% downward over the past 30 days.

Factors Affecting Arch Capital

The P&C insurer continues to suffer from increased costs, primarily owing to higher losses and loss-adjustment costs, acquisition expenses, other operating costs, interest expense and corporate expenses. Such costs tend to put pressure on the company’s margin expansion. Notably, in first-quarter 2020, net margin contracted 380 basis points sequentially.

Being a P&C insurer, Arch Capital remains exposed to catastrophe losses, which, in turn, has been impacting underwriting results. Consequently, the company’s underwriting results were primarily dented due to the COVID-19 outbreak-induced financial turmoil, which, in turn, has led to the deterioration in its combined ratio in the first quarter. Also, it expects the pre-tax underwriting results of its mortgage segment to remain at low levels through the remainder of 2020.

Net investment income, an important driver of Arch Capital’s top-line growth, has declined in first-quarter 2020. Consequently, revenues have declined 12% sequentially and 11% year over year in first-quarter 2020.  Also, the prevailing low-interest-rate environment is likely to keep investment yields under pressure. Moreover, equity market fluctuations weigh on the company’s overall investment income.

Furthermore, the P&C insurer’s debt levels have escalated 264.7% for the past five years. Following the trend, debt levels have also increased in first-quarter 2020. As of Mar 31, 2020, its total debt to total capital of 19.6% is higher than the prior quarter’s figure of 18.8%. The P&C insurer’s interest coverage ratio of 11 compares unfavorably with the prior quarter’s figure of 16.3, which implies that its earnings are not sufficient to cover interest obligations.

Additionally, Arch Capital’s trailing 12-month return on assets of 3.02% is lower than the industry’s 3.12%. This implies inefficient utilization of assets of the company.

We believe that such potential headwinds are likely to dent its growth prospects, going forward.

Stocks to Consider

Some better-ranked stocks in the insurance space are American Equity Investment Life Holding Company AEL, The Allstate Corporation ALL and Amerisafe, Inc. AMSF, each carrying a Zacks Rank #2 (Buy) at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

American Equity Investment is a full service underwriter of a broad line of annuity and insurance products, with a primary emphasis on the sale of fixed-rate and index annuities. It beat estimates in each of the trailing four quarters, the positive surprise being 63.04%, on average.

Allstate provides a range of life insurance and investment products to its diverse customer base. It beat estimates in each of the trailing four quarters, the positive surprise being 18.45%, on average.

Amerisafe is a specialty provider of workers’ compensation insurance, which markets and underwrites its insurance through subsidiaries. It beat estimates in each of the trailing four quarters, the positive surprise being 50.67%, on average.

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