Lancashire Holdings (LSE: LRE) has long been a core holding of Neil Woodford’s. At both Invesco Perpetual and Woodford Investment Management, Lancashire has helped the highly-regarded fund manager accelerate his returns over the years and there’s no reason why you can’t jump on the band-wagon as well.
Experienced operator
Lancashire is a dividend champion. The majority of the returns from the shares over the past few years have come from dividends as management has prioritised shareholder returns. I see no reason why this shouldn’t continue.
Insurance companies such as Lancashire have always been great income investments. That’s why billionaire Warren Buffett built his empire at Berkshire Hathaway around a core of insurance names. And Lancashire is the perfect example of a well-run insurer that looks after its investors. Strict insurance underwriting controls ensure that the group is not taking on excessive insurance risk and, as a result, losses as a percentage of underwriting income have averaged 72% per annum for the past five years — one of the best ratios in the industry.
As insurance rates have dropped over the previous two years, Lancashire’s underwriting controls have held the group back from chasing uneconomic deals. This has held back the group’s revenue growth although it is arguably the most sensible strategy.
Lancashire has also been taking advantage of low reinsurance rates to reinsure some of its insurance contracts at a low cost in order to free up capital, which has then been returned to shareholders.
Dividend champion
The combination of Lancashire’s desire to hold back from uneconomic deals, risk-reducing reinsurance and a lack of substantial insurance payouts during the past five years has enabled the group to return an enormous amount of capital to investors since 2011. For the past three years, the group has returned more than 100% of income to shareholders via dividends, and this could be set to continue if the group sticks to its conservative strategy.
Lancashire is able to return more than 100% of its income to investors because of the way insurers provision against losses. Lancashire’s management generally overstate any losses the group might have to pay out, so when the final figures are produced (up to three years after the event), Lancashire is generally better off than it forecast. And because the company has no need for hefty capital expenditure, the cash released is surplus to requirements.
Thanks to these reserve releases, Lancashire returned a whopping 187% of its income to investors last year.
Nonetheless, insurance is an unpredictable business, so Lancashire’s management has decided to pay profits out via a large special dividend once a year, on top of a regular token payout. This year the special payout is 60p per share, following last year’s £1.05 per share. Since the beginning of 2011 Lancashire has returned £5.02 per share to investors via dividends. If you had acquired 100 shares in Lancashire at the beginning of 2011 for £544 and reinvested all dividends today you’d have a holding worth £1,301 for a total return of 139.2%.
It’s no wonder Lancashire is a Neil Woodford favourite.
