ALL Allstate Corporation

We reiterate our recommendation on Allstate Corp. (ALL) based on the current sustainability factor. The company’s second quarter operating loss of $1.23 per share came in modestly lower than the Zacks Consensus Estimate of a loss of $1.53 but lagged the year-ago quarter’s earnings of 81 cents per share.

Results for the quarter reflected higher catastrophe (CAT) losses that also led to increased claims expenses coupled with lower average premiums and policies-in-force in Property-Liability insurance unit and lower investment income. However, prudent capital management and strong liquidity were quite impressive during the reported quarter. This is reflected in the growth in book value per share and improved combined ratio, excluding the effect of catastrophes.

As Allstate deals with property and casualty business, it is significantly exposed to catastrophic events. Given the consistent occurrence of weather-related events, catastrophe losses surged to $2.67 billion in the first half of 2011 itself from $2.21 billion in 2010 and $2.07 billion in 2009.

Escalating losses from catastrophes have been weighing on the company’s claims and benefits expenses while also significantly deteriorating the company’s combined ratio, bottom-line results and cash flows. Though the company is focusing on reducing losses through its catastrophe management strategy, we cannot rule out the possibility of significant losses from catastrophes and severe weather incidents, going forward.

Moreover, the economic slowdown and a weak P&C cycle continue to narrow down the growth prospects in the Property-Liability segment. As a result, premium growth remains curtailed and the company is experiencing a decline in underwriting results, policies-in-force and new issued applications.

Besides, Allstate’s investment portfolio has been witnessing a rough patch due to the ongoing equity market declines and sluggish returns. As a result, net investment income has narrowed and is expected to continue to remain weak until the economy rebounds to its historical highs and maintains stability.

However, prudent capital management remains Allstate’s forte. Management’s proactive risk mitigation and return optimization programs continue to enhance shareholder value. This is reflected in the company’s ongoing $1.0 billion share repurchase program and the 5% dividend appreciation in February 2011 after a sharp reduction in 2008.

Further, statutory capital levels remain sound and the company continues to have access to funds of $1 billion from either commercial paper issuance or an unsecured credit facility expiring in 2012. Looking ahead, we believe that effective capital management, comprehensive enterprise stochastic model and modest operating cash flows will be able to boost the company’s operating and competitive strength vis-a-vis arch rivals such as Berkshire Hathaway -A (BRK.A), The Travelers Companies (TRV) and Ace Limited (ACE).

Additionally, solid risk-adjusted capitalization, competitive strength, favorable non-catastrophe operating results along with comparably strong underwriting capabilities and investment leverage bode well for future growth. These factors also led the rating agency -- A.M. Best, to issue a stable outlook on Allstate and its subsidiaries’ credit, debt and financial strength ratings.

In order to gear up its Property-Liability segment, particularly the online auto sales where the company has been underperforming since the past 3 years due to loss of clients, Allstate is expected to acquire the third largest online auto insurance seller in the U.S. – Esurance and Answer Financial from White Mountains Insurance Group Ltd.

The $1.0 billion deal is expected to close by the end of the third quarter of 2011, it is also projected to boost online auto sales and generate cost synergies. The deal is also expected to expand Allstate’s online sales, whereby the company will be able to tap a large consumer group and offer them a good brand with a wider choice of products. The acquisition is expected to break even by the second full year of ownership and accretive to earnings beyond the second year.

Overall, weighing all the pros and cons, the Zacks Consensus Estimate of earnings is currently pegged at 75 cents for the third quarter of 2011, down about 10% year-over-year. For 2011, earnings are projected at $1.38 per share, down about 51% over 2010, given the weak global cues and impact of catastrophes on the results.

Additionally, the quantitative Zacks Rank for Allstate is currently #3, indicating no clear directional pressure on the shares over the near term.

 
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