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Online Extra: Has Progressive Gotten Ahead of Itself?


Eric Wahlgren The stock of auto insurer Progressive Corp. (PGR) has been in the fast lane for a while. Last year alone, its shares gained 68%, compared to a 26% rise in the benchmark Standard & Poor's 500-stock index. Progressive, the third-largest auto insurer, has also been a good bet over the long haul. Shareholders have realized compounded annual returns of 20.4%, including dividend reinvestment, in the decade since December 31, 1993, compared to an 11% gain for the S&P 500, according to Progressive's annual report.

Progressive has few equals in the auto insurance business. Thanks to competitive pricing and a reputation for customer service, the Mayfield Village (Ohio) company sold 26% more in premiums in 2003 than it did in 2002, while the rest of the industry averaged growth in the mid-single digits, estimates Nick Pirsos, an analyst with Sandler O'Neill & Partners in New York. "Operationally, it's an outstanding company, arguably the best," says Pirsos. This year, Progressive came in at No. 1 in the BusinessWeek 50, the magazine's annual rating of the top 50 companies in the land.

HARDER TO DUPLICATE. Despite its stellar performance, Progressive appears to have eased up on the accelerator in 2004. Year-to date, the stock was up 4%, to $86.88, as of Mar. 25. That was better than the S&P 500, which was down over the same period, but not as much as investors are accustomed to. And in spite of their admiration, many Wall Street analysts have no better than hold ratings on Progressive.

The Street has two main reasons for its lukewarm assessment. For starters, competition is expected to rev up. Auto insurers are ready to trim prices for premiums, especially those written for higher-risk drivers, also known as the "nonstandard" segment. "There are a number of new entrants in the nonstandard auto segment that have recently gone public and are looking for growth," Pirsos says. He also expects Progressive to face more competition in the standard segment, motorists with average risk.

And some of the strong year-over-year growth rates Progressive achieved in the past by moving into new markets will be harder to duplicate now that it's already in these markets and starting from a higher base. "In 2004, premium growth will slow down," says Pirsos, who has a hold rating on the stock and a $90 price target, which suggests 4% appreciation from current levels in the next 12 months. (Pirsos' firm may do investment-banking business for Progressive in the future.)

NOT "BETTER DRIVERS." What's more, a favorable trend that has been boosting profits for Progressive -- and its rivals -- is expected to wane in 2004. In recent months, the number of claims filed for accidents and other car troubles declined, meaning insurers had to pay out less cash to customers. No one seems to know why fewer claims were filed, though one theory holds that drivers are leery about submitting them for fear their rates will go up. As Ira Zuckerman, an analyst with Nutmeg Securities in Fairfield, Conn., says: "We know it's not true that there are better drivers on the road."

Analysts like Zuckerman believe the "claims frequency" fall-off will eventually stop or reverse. And "when claims frequency stops declining, losses will increase," says Zuckerman. He has a market-perform rating on Progressive and, like Pirsos, a target of $90. He bumped the stock from his buy list when it topped $83 in January. "I love the company," says Zuckerman. "I'm just not enamored of the stock price." (Zuckerman has no ties to Progressive, nor does his firm.)

Analyst estimates for Progressive's fiscal 2004 indicate a slowdown in profit growth after net income nearly doubled in 2003. Progressive is expected to report about 1% higher net income of $1.26 billion, on 16% higher revenues of $13.8 billion this fiscal year, according to earnings tracking service Thomson First Call.

A NEW BULL. Progressive declined to speak with BusinessWeek Online for this story, citing a policy of not commenting on analyst reports or investment recommendations. But in a Jan. 22 conference call with investors, Progressive Chief Executive Glenn Renwick said it monitors trends to make sure that premium rates don't become "inadequate" if claims filings rise. As for competition, Renwick said Progressive would consider cutting rates in certain markets if necessary.

The CEO also said premium growth would continue at "several multiples" of the industry's rate. "We approach the 2004 year extremely well-positioned," said Renwick. "While we expect and forecast lower year-over-year percentage growth than in the two past years, we could not be in a better position with strong margins and excellent operational capacity -- notably claims quality."

Despite Renwick's lower expectations, Lehman Brothers analyst Chris Winans has recently become bullish on the stock, citing in part Progressive's results for the month of February, when it posted 63% higher net income, $145.1 million, over the same month last year and a wider underwriting margin than the year-ago period. In a Mar. 19 note to investors, Winans raised his rating to overweight -- Lehman's highest -- from underweight. He also jacked up his target price to $105 from $78, which means he thinks the stock could add some 21% in the next year or so.

SAVVY "SEGMENTATION." Winans writes that the change reflects "our view that the company's strong underwriting performance, earnings growth, and book-value growth are all more sustainable than we previously thought." (Neither Winans nor his firm has any ties to Progressive.)

Another strength for Progressive is robust margins. In 2003, it enjoyed a fat 12.7% underwriting margin, reflecting the difference between premiums collected and claims paid. For the industry overall, underwriting margins were closer to 0.9%, Progressive estimates.

In particular, Progressive's forte is "segmentation" -- breaking groups of drivers into smaller and smaller groups to better predict loss patterns, Nutmeg's Zuckerman says. And most insurance companies make profits by investing the cash flow from premiums until they have to pay claims. Progressive has a conservative portfolio with 85% invested in bonds and 15% in stocks.

MONTHLY REPORTS. Progressive also has a solid record of innovation in customer service, says Pirsos. It's a leader in rolling out concierge-like services, such as allowing customers to drive directly to a Progressive shop and pick up a rental car to use until their vehicle is repaired.

Richard Moroney, editor of financial newsletter Dow Theory Forecasts in Hammond, Ind., likes the fact that Progressive reports earnings monthly as well as quarterly. Most companies update shareholders on financial performance only four times a year. Moroney's firm sold its Progressive shares after they hit the $70 level last year, and he has a hold rating now. "But if the stock were to pull back, we would like to get back into it," says Moroney.

Looking ahead, Progressive is likely to gain market share from its two larger rivals, analysts say. It has about 7% of the market, after No. 1 auto insurer State Farm, which has about 20%, and No. 2 Allstate (ALL), which has about 12%, Zuckerman says. But "Progressive has been taking market share for years, and they will continue to do so," he predicts.

As auto insurers go, Progressive is about as solid as it gets. However, many on the Street believe investors probably would do best waiting for the stock to get dented before adding it to their portfolios. Wahlgren covers financial markets for Business Week Online in New York

EDITED BY Beth Belton


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