Is Mercury General the best Auto Insurance Stock?

A company you have probably never heard of; Mercury General (NYSE: MCY), might be the best dividend investment in auto insurance.

If you’re unfamiliar with Mercury, don’t be surprised because it’s a rather small company. Mercury reported TTM revenues of $3.221 billion and a net income of $110.87 million for the second quarter of 2016. It also reported a market capitalization of $2.951 billion, assets of $4.722 billion and an enterprise value of $2.826 billion on August 11, 2016.

What is big at Mercury was its dividend yield of 4.64% on August 11, 2016. That is certainly in contrast to Progressive’s (NYSE: PGR) dividend yield of 2.61%, Allstate’s (NYSE: ALL) and Cincinnati Financial’s (NASDAQ: CINF) 2.46%.

Buy This Company Just for the Dividend

Mercury General is one of those rare companies that you should buy just for the dividend yield. It has delivered a dividend yield of over 4.5% for the last five years according to ycharts.

More importantly that dividend yield has sometimes been much higher. It was 5.62% as recently as January 19, 2016. That gives it a high dividend yield and a steady yield, which makes this stock ideal for a long term addition to a portfolio.

Interestingly enough the dividend is the only thing in Mercury’s financial numbers I actually like. Some of the other figures like cash from operations ($218.74 million on June 30, 2016) and cash and short-term investments ($414.58 million) were rather low for my tastes.

My guess is that those numbers are low because Mercury pays out a lot of its cash in the form of dividends. That’s not a good business model for those who want growth in their portfolio, but is good for those who are looking for steady income.

So what is Mercury General Anyway?

Despite the limited cash Mercury has some of the attributes of a value investment. It’s rather obscure and in a very unsexy business, which gives it stability that some dividend payers like mortgage real estate investment trusts; the notorious MREITs lack.

Mercury General is an independent automobile insurance broker and agency writer. Mercury is rather obscure because it sells most of its policies in one state. Yet it makes a lot of money because that state is California; the nation’s most populous with around 39 million residents.

Mercury is now the largest privately owned car insurer in the Golden State. It also writes auto insurance policies in nine other states.

Mercury General’s Advantage

Those states are Florida, Texas, Georgia, Nevada, Arizona, Illinois, Virginia, Oklahoma, New York and New Jersey.  That does not sound like much until you rank the states by population.

The nation’s four largest states by population are California, Texas, New York and Florida, according to the US Census Bureau – and Mercury operates in all of them. Those four states have a population of around 106 million people which gives Mercury a market of nearly one third the nation’s population.

More importantly when you look at the Census Bureau’s list of the top 10 states by population, you will notice that six of them; California, Texas, Florida, New York, Illinois and Georgia are Mercury markets. Mercury’s geographic reach is limited but it reaches the areas with the most people. When you add Georgia and Illinois to the numbers the potential market increases to 129 million people.

Mercury’s markets are also poised for growth four of the states it operates in; Nevada, Texas, Arizona and Florida appeared on the Census Bureau’s list of the fast growing states for 2013 and 2014. Even more interesting is Census Bureau’s list of 10 States with the Largest Numeric Increase in Population for July 1, 2013 to July 1, 2014.

The top five states on that list are Texas, California, Florida, Georgia and Arizona all of which are Mercury markets. During the year between July 2013 and July 2014 those states added 1.315 million people to their populations. Another Mercury Market; Virginia appeared on the numeric list as well.

These numbers give Mercury a highly concentrated market that contains the nation’s highest population states; and some of its fastest growing markets. That provides room for a lot of organic growth with limited marketing costs.

The business model is working too, between June 2015 and June 2016, Mercury’s revenues grew by $308 million or nearly 10%. Mercury reported revenues of $2.913 billion in June 2015 that grew to $3.221 billion in June 2016.

That revenue growth and the geographic concentration offer a real potential for long term growth at Mercury; something that may not exist at more geographically dispersed insurers like Progressive and Allstate. Allstate’s revenues grew by just $12 million between June 2015 and June 2016, rising from $35.62 million in 2015 to $35.75 indicating that company might have reached limits of its growth.

Is Mercury’s Business Model Better than GEICO’s?

Its business model gives Mercury an advantage over companies like Berkshire Hathaway’s (NYSE: BRK.H) GEICO; because it has a highly concentrated market. That limits marketing and advertising costs.

GEICO alone spent $935.10 million on advertising in 2013, Insurance Business America reported. During the same year advertising cost Allstate $654.8 million, State Farm, $608.10 million, Progressive $604.20 million, Nationwide $296.70 million and Liberty Mutual $197 million.

The narrow market allows Mercury to build other costs into the system including lower costs for claims administration. Another advantage is that Mercury can sell through select independent brokers and agents in specific high volume markets.

The business model is not perfect but it is profitable. It’s also the kind of company Ben Graham might buy into if he was alive and investing today.

If you’re thinking of adding an auto insurance company to your portfolio, Mercury would be a good choice. The dividends, potential for growth and simple business model make it a very attractive contrarian play.