by Hilary Kramer | March 10, 2014 2:38 pm
Editor’s note: This column is the latest update in our 10 Best Stocks for 2014 contest. Hilary Kramer’s pick for the contest is Fortegra Financial (FRF).
I am a big fan of financials, which is why I named Fortegra Financial (FRF) as the best stock of 2014. Fortegra isn’t your traditional bank or financial company, but it has great potential.
FRF provides payment protection and other insurance services. It has worked to expand its product offerings in the fastest-growing areas of insurance to increase its customer base while meeting their biggest demands. That growth potential is strong, and a string of acquisitions will also help build the company’s business and open up new sources of revenue.
It’s true that the stock had a rough start to 2014, falling around 16%, but I see this as a good value play and not a short-term holding, which is why I’m not concerned about the drop.
Let’s take a look at the factors behind the decline:
First, Fortegra stock has been stuck in a trading range between $7 and $8.50 after reporting disappointing earnings for the fourth quarter of 2012 on March 28. I believe the market is waiting for greater consistency from FRF’s payment protection division before it bids the shares higher. These concerns have been exacerbated by management’s recent sale of their insurance brokerage business, which has left the payment protection unit as the biggest part of the company (excluding its tiny Business Process Outsourcing (BPO) unit).
While FRF obtained an attractive multiple of 9.0 EBITDA for this unit, the immediate impact of the sales will be dilutive to earnings, until the company redeploys the $83.5 million it received from the transaction. Considering Fortegra has an enterprise value (Equity Value + debt –cash) of $238 million, the proceeds received are very significant, and the market may be looking for clues on how the capital will be deployed before committing to the shares.
Secondly, with the company owned 62.1% by private equity firm Summit Partners, less than $200,000 worth of stock trades in a day on average , making it difficult for larger investors to build a position. And lastly, the company is very quiet by nature, and I think the lack of news flow certainly hasn’t helped the stock break above resistance, especially when you consider the disappointing fourth-quarter results.
Having said that, I still like Fortegra stock here. Even assuming EPS declines by 10 cents a share from the expected 83 cents a share in 2013 due to the divestiture of the insurance brokerage business, (a conservative assumption which assumes no re-investment of the proceeds) the stock is currently trading for less than 10X this year’s EPS. I find this very attractive for a financial stock that earns money through fee income, and takes limited risk with its balance sheet.
Management has been lowering their net debt balance that rose from recent acquisitions, which I consider a sign that FRF’s earnings are of a high quality, an important consideration when analyzing financial stocks.
Fortegra is due to release fourth-quarter earnings within the next few months, quickly followed by first-quarter 2014 results. I am expecting profitability at payment protection to remain stable, as management will be eliminating marketing programs they were not productive.
Growth in the top line is a little less clear, but I think it is important to remember that FRF’s products have been around more than 30 years, and have a history of consumer acceptance, so the company does have a solid base to build, and at the very least generate a consistent stream of cash.
Management is disappointed in the Fortegra stock price, and have said that they will do all they can to enhance shareholder value. With Summit also anxious to maximize value of this very inexpensive stock, and with FRF down since its $11 per share IPO in 2011, an effort to sell the company or another type of transaction to enhance value is a real possibility.
Good things happen to those who wait, and while it may take some time for FRF to take off, I am still confident that we’ll see Fortegra stock move higher in 2014.
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