Kinsale Capital Group Inc. (KNSL, Financial), a niche player in the excess and surplus insurance market, continues demonstrating robust growth and strong financial performance. Despite disappointing results in the fourth quarter of 2023 and the first quarter of 2024, the company's second quarter was robust, reflecting its strong business model and strategic execution. Even with broader insurance industry challenges, Kinsale has managed to exceed expectations and deliver impressive results. The stock reaction was promising, but it remains down more than 20% from all-time highs at the time of writing.

Financial health and outlook

In its recently reported second-quarter earnings, Kinsale revealed a strong balance sheet with about $3.60 billion in cash equivalents, marketable securities and short-term investments. The company is well-positioned to continue investing in its future growth. Further, the long-term debt and reserves worth $2.20 billion is well-covered.

One notable aspect of the company is its ability to sustain growth while maintaining a conservative approach. In a statement, CEO Michael Kehoe said, “Our second quarter results were driven in part by another quarter of actual losses being below our expectations. Now, withstanding the favorable quarterly loss experience, we continue to take a cautious approach to reserving, to prospectively stay ahead of loss trend.”

When insurance companies mention "releasing reserves," they refer to adjusting funds based on actual loss experience. If actual losses are lower than initially reserved, these reserves can be "released" back into earnings, reflecting a cautious approach to ensure sufficient coverage for claims while recognizing overestimated potential claims.

Turning to the income statement, Kinsale saw impressive growth across all product categories. Total revenue grew 34% year over year to $384.6 million, driven by a strong increase in gross written premiums and net investment income. Gross written premiums gained 21% year over year to almost $530 million, while net investment income jumped 48% to $36 million. Despite a 5 basis point contraction in the net income margin, it remained healthy at just over 24%. Operating expenses grew at a slower pace than revenue, highlighting efficient cost management.

Shares outstanding were flat, despite growth in the top and bottom lines. However, Kinsale's underwriting profitability, measured by the combined ratio, increased by 100 basis points to 77.70% (lower is better). This translates into an expense ratio of 21.10%, which remains outstanding compared to peers. The combined ratio mainly increased due to a higher loss ratio.

Source: Kinsale IR Presentation

Looking ahead, Kinsale's management is optimistic about its prospects, though it did not provide guidance. Wall Street is expecting revenue to grow 27% in the third quarter, reaching just under $400 million, while earnings per share is expected to increase 11%.

Business model and market position

Kinsale operates as a managing general underwriter, focusing on hard-to-place risks for small and mid-sized businesses within the E&S insurance market. This niche market requires specialized knowledge and underwriting expertise, which the company has leveraged effectively to maintain a competitive edge. It has consistently generated best-in-class returns while capturing market share from competitors.

Despite its relatively small size, Kinsale achieved significant market share growth in 2022. This trend continued with impressive growth rates throughout 2023 and the first quarter of 2024, outpacing the industry average. The company's rapid expansion highlights its unique ability to navigate the complexities of the E&S market successfully.

Source: SPGlobal

Kinsale has seen substantial growth in various divisions, including small property, entertainment and general casualty. Newer divisions like high-value homeowners and commercial auto are also expanding, contributing to the company's diverse portfolio.

The company's strategy of focusing on smaller accounts, low-cost underwriting and leveraging technology allows it to achieve lower costs and better margins. It maintains absolute control over underwriting and uses technology to manage costs, achieving a combined ratio well below the industry average.

The company has built a technology platform that increases the efficiency and accuracy of the underwriting process. The data obtained in the E&S market is not available anywhere else, providing a significant competitive advantage. With 20% of its workforce dedicated to IT, Kinsale enhances underwriting accuracy and efficiency. The company has around 560 employees in total. This gives an average of $2.50 million in revenue per employee annually. Also targeting less competitive, higher-margin segments within the E&S market allows Kinsale to achieve superior returns.

Another point in favor of Kinsale is its founder-led structure. Companies with founders actively involved often have strong alignment with shareholder interests. Michael Kehoe founded the company in 2009 after working at James River, a larger E&S insurance company. Kehoe owns 4% of Kinsale and total management holds 5.60%. This skin-in-the-game approach aligns management's interests with those of shareholders, ensuring a strong commitment to the company's success.

Risks and challenges

While Kinsale's business model and financial health are strong, the company faces several risks and challenges.

Natural disasters pose a significant risk to any insurance company. Despite Kinsale's effective risk management strategies and diversified portfolio, major catastrophes can still lead to substantial losses. For example, last quarter saw significant activity with Hurricane Beryl being the most impactful, though the company managed to keep losses minimal. The unpredictable nature of such events always presents a risk.

The economy is still recovering from the supply-led inflation shock. There are concerns that demand-led inflation could spike in the coming months, especially with potential rate cuts from the Federal Reserve. Rising costs can erode underwriting margins and investment gains. Inflation particularly affects long-tail lines, making it crucial for Kinsale to maintain conservative pricing and reserving strategies. On the other hand, there are concerns about a hard-landing recession. In such a scenario, economic activity would contract sharply, leading to higher default rates among policyholders and potentially increasing the frequency and severity of claims. Additionally, a recession could depress asset values, affecting its investment income.

Lastly, the evolving tort system can lead to increased claim costs. The company remains vigilant about changes in the legal landscape and adjusts its strategies accordingly to stay ahead of potential liabilities.

Market opportunities

The E&S insurance market represents a specialized sector that fills the gaps where standard insurance hesitates. Kinsale addresses challenging and often high-risk cases, ranging from mobile homes to multinational oil companies and everything in between. These high margins allow Kinsale to balance the trade-off between margin to growth strategically. In some instances, it will accept a lower return on equity for higher growth, while in others, it will trade lower growth for higher margins. Kinsale has a threshold for minimum ROE and is willing to refuse business that does not meet this criteria, as it has done in the past.

Source: Board of Governors of the Federal Reserve System

Recent data from the United States Commercial and Industrial Loans indicates a slight rebound in the last quarter in terms of loans for this segment. This growth, fueled by the potential for lower interest rates in the second half of 2024 or first half of 2025 is likely to help Kinsale's continued expansion.

Kinsale's diversified portfolio across various divisions, including property, casualty and speciality lines, reduces its dependency on any single market segment. This diversification strategy not only helps the company manage risks more effectively, but also allows it to seize growth opportunities across different sectors.

The company has recently expanded into newer divisions such as high-value homeowners and commercial auto, showcasing its ability to identify and capitalize on emerging market opportunities.

Valuation

Currently, 12 analysts cover Kinsale's stock, with two giving it a buy rating and 10 a hold rating. The average price target of $452.30 over the next year suggests a fairly priced stock.

Kinsale trades at 28 times earnings and and an enterprise value/Ebitda ratio of 20. While these might seem high on an absolute basis, they are among the lowest valuations the company has traded at historically. Considering its growth prospects, the forward multiples of 25 times 2025 earnings and 19 times 2026 earnings appear more reasonable.

Source: FinChat

Compared to peers such as American Financial Group (AFG, Financial), Assurant (AIZ, Financial), Old Republic (ORI, Financial), CAN Financial Corp. (CAN, Financial), RLI Corp. (RLI, Financial) and Palomar Holdings (PLMR, Financial), Kinsale has a higher price-earnings ratio. However, the company has superior metrics, the least amount of debt, the highest revenue growth and the highest Ebitda and net margins to justify the premium valuation.

Management did not provide specific guidance targets or growth forecasts. However, market expectations indicate two-year forward revenue growth of 24.13% annually and earnings per share growth of 19.14%.

Despite a nearly 20% increase since the last earnings report, I believe Kinsale remains a compelling investment. At the current multiple of 28, the company offers a significant discount to its 10-year average multiple, especially considering it has been doubling in size every two years. This presents a good opportunity to start a position in this growth compounder.

Conclusion

Kinsale Capital has demonstrated its ability to grow profitably and manage risks effectively. With a strong balance sheet, a committed management team and a strategic focus on leveraging technology for low-cost underwriting, Kinsale is well-positioned for continued success. The company's recent financial performance and market strategy suggest a promising future, making it an attractive investment opportunity.

As a long-term investor, I remain bullish on Kinsale due to its strong fundamentals, growth potential and effective risk management strategies. The company has had a tough time since it peaked in March, being down more than 30%, but has recovered since then. The company is still early in its life phase and is doing things right. This is a great company to hold for the long term, and I do not plan to sell my stake anytime soon.