Stewart Information Services Corp Q1 FY2021 Earnings Call

Hello, and thank you for joining the Stewart Information Services First Quarter 2021 Earnings Call. Please note, this call may be recorded. It is now my pleasure to turn today's conference over to Nat Otis, Head of Investor Relations. Please go ahead.

Thank you, Brendon. Good morning. Thank you for joining us today for Stewart's First Quarter 2021 Earnings Conference Call. We will be discussing results that were released yesterday after the close. Joining me today are CEO, Fred Eppinger; and CFO, David Hisey. To listen online, please go to the Stewart.com website to access the link for this conference call.

Good morning, everybody, and thank you for joining us today for Stewart's First Quarter of 2021 Earnings call and for your interest in Stewart. Before I turn it over to David to go through the details of the quarter's results, I wanted to touch on a few topics as we move into 2021. I’m very, very pleased with the progress this quarter. We clearly capitalized on the historic market strength, but we also continue to improve our underlying financial strength and the resiliency of the company. We grew share in a number of critical markets. We added some service capabilities and leveraged our improved technology platform. As we look ahead, we envision a Stewart that not only takes advantage of the high point of the cycle, but can also thrive through the entire business cycle. The foundation of this future lies in a more strategic and disciplined operational approach to investments, and a company culture that is focused on moving quickly to adapt and to capitalize on opportunities to improve and grow the company. While our journey is not finished, the work our employees have accomplished last year and throughout the first quarter addressing the challenges of the pandemic conditions driving structural changes, integrating more valuable talent and asset additions have all fundamentally changed our company. The results to date are encouraging and illustrate that we are on the right path. Given what we have accomplished to date and our view of the market outlook, we are very bullish on the company's opportunities for the next two or three years. As we look at 2021 and 2022 and beyond, there is a level of uncertainty over the endurance of the cycle even as we continue to experience strong market demand. We know the refinancings will begin to slow at some point, even though the overall residential market is healthy and is expected to remain that way for some time as resale transactions driven by pent-up demand and favorable homeowner demographics will continue to show strength. In this kind of market, there will be winners and losers, and we are positioning ourselves to be one of the winners.

Thank you, Fred, and good morning. Let me also thank our associates for their continued operational service and our customers for their steadfast support. The year opened with a strong residential real estate market, driven by powerful demand, favorable interest rates and improving economic conditions. On the medical front, virus news is generally improving as vaccinations increase, although there are variances in vaccine distribution that create challenges in the pace of recovery. Even with an improving economy, there continues to be a high mortgage delinquency and forbearance, the effect of which needs to play out. Let me provide some broader context consistent with Fred's comments before I review the quarter's results. Although interest rates and the economy provide some volatility to the operating environment, our strategic areas of focus—gaining scale in attractive direct markets, improving agent service capabilities and geographic focus, and scaling lender services—are beginning to have a meaningful and durable impact on our results. Over time, we will see the benefits of our commercial initiatives as that market returns. For the first quarter of 2021, Stewart reported net income of $54 million and diluted earnings per share of $2.01 on total operating revenues of $681 million. On an adjusted basis, the Q1 net income improved by $38 million compared to $13 million from last year's quarter as we disclosed in Appendix A of the press release.

And we will take our first question from Bose George with KBW. Please go ahead.

Hey everyone, good morning. First question: just on the residential direct premiums, they fell by— I think it was 10% over the fourth quarter. The agency premiums fell pretty modestly. So is there something to call out in terms of the differences between what we saw in those channels?

I missed that—I'm sorry. Help me with that, because I couldn’t hear it correctly. What was the question?

Yes. Basically, I was looking at the decline in the direct channel. There was about a 10% decline in the residential national direct premiums over last quarter, and the agent premiums were almost flat—just about a 1% decline over the last quarter. I was just curious why the differences between the two channels?

Bose, are you including commercial?

Actually, I pulled out commercial because including commercial it is more like a 20% decline versus 1%. So with commercial pulled out, it seems like it was about 10% versus 1%. We can follow up on the specifics later.

Yes. What we saw was this was the strongest direct first quarter we have ever had for us. It was very, very, very strong versus the last first quarter. Traditionally, the first quarter is seasonal, but this year we were incredibly strong. The agency growth for us is a combination of a couple of things. The agency growth got stronger all through last year as we recovered from a disruption period. So the comparison from first quarter last year to this year on agency is extraordinarily strong because we have so much momentum getting agents back that we had lost a little bit during the fidelity situation, plus the new growth initiatives we have. So agency had a great comparison quarter-to-quarter, which gives you the robust growth. What you didn't have is the same kind of drag in the first quarter for direct that you had in agency from the hangover. So there may be a delta between the two because of that.

Okay. That makes sense. And then can you talk about your latest thoughts on acquisitions? Do you feel like acquisitions remain part of the puzzle for getting margins up, or do you feel you've done a fair amount of what you need on that side?

Yes. We are very focused. We continue to focus on what I would call local market strategies. We still have a number of markets where I would like us to have a greater share, and it is all about market consistency through the cycle to better manage margins and consistency of service. We are going to continue to be focused on a number of markets in the top 140 MSAs where we believe we should gain share. Some of that will be acquisitions; we still have a robust pipeline of acquisitions in front of us. Some of it is organic as well. One of the interesting things that has happened is we have a lot of momentum right now and our ability to attract talent has never really been better. So we are seeing a lot of folks come to the company as well. It will be a combination of organic growth in target markets and acquisitions. One of the things we are trying to do is not just gain share for margin—we also want to broaden our service capabilities. Particularly on the agency side, we want to continue to provide additional services. You saw that with the ASK acquisition we just did, which provided us additional services for our agents. So acquisitions will remain part of the strategy.

Okay. Great. Can I sneak in one more on the loss ratio? What is the kind of normalized number, and can you discuss the change between last quarter and now? What was the pre-bump in your modeling?

Yes. If you remember last year, we wanted to take a conservative position in the fourth quarter in particular as we looked out and saw risk. If you look at the balance of last year, I think the loss ratio for the balance of last year was something like 5.3% or thereabouts.

Okay. Great, thanks a lot, nice quarter.

Thank you.

And our next question is coming from John Campbell with Stephens Inc. Please go ahead.

Hey guys, good morning, congrats on the continued success. I'm getting a fair amount of questions on this, so I figured I should ask. There's some noise out there with a large competitor of yours—I'm sure you are hearing the same thing—but I'm curious about your appetite around larger transformational title insurance share grabs and your ability or capacity to do something of size?

Yes. We don't comment on other companies in our calls, but as Bose asked, we are trying to build market-by-market and segment-by-segment. We think about scale and size that way; it's a bottom-up view rather than a top-down look. We are constantly looking for opportunities to enhance capabilities or achieve scale so the stability of our economics improves. That will be part of what we do. We don't feel like we need a transformational event. I believe the journey we are on shows traction and we are closing the gap with major competitors. Would I like us to be better? Yes. We will continue to focus at a market level, do some acquisitions and fill-ins, and acquire capabilities. But in my view, we don't need anything transformational to change our outlook and continue to outgrow and outperform the market over the next two to three years. We just have to focus on building our business.

Okay. On title—you're hitting on all cylinders—if you look at the ancillary services business, I think your revenue was ten times higher versus last year. The turnaround has been impressive. Can you talk about the updated products you have today and the product roadmap? What might the desired end state look like?

Yes. I'll take a couple pieces of that. From my perspective, when you think about the potential evolution of the title process, having a strong remote notary capability and notary network is incredibly valuable. Controlling quality, access, and integration into the overall process was important, and we invested significantly there. We will continue product innovation in that area as we take assets like Signature and NotaryCam—or similar capabilities—and think about the combined entity to make us better. On the appraisal side, we thought that was critical to the roadmap to have both scale and a technology platform for an evolving world. We also think appraisal is a consolidating business because it needs to be more innovative and technology-savvy. We have positioned ourselves to continue to grow that business and cover the market effectively. The overall ancillary approach was to build scale in areas where we can be a winner, to help our position with clients and succeed in those individual businesses. I think we have the scale and we are on track with margins. There is some consolidation work on recent acquisitions that will enhance margins further. We continually evaluate where we should own versus buy in services areas—examining sub-product sets and data sets so we can maintain a robust ancillary portfolio that supports the company. Historically, ancillaries were a help to competitors' margins and a drag for Stewart. We had many small businesses that could lose one customer and lose money. We have now restructured that to support our core business and be accretive to earnings going forward. Do I want to grow that business? Yes. It is an area of continued focus.

That's a great rundown. Quick follow-up—maybe for David. If you look at that segment, backing out corporate expense and net realized gains, I'm getting to about a 4% underlying margin for ancillary services within those entry services. Where do you think that margin can go? Mid-teens, low teens?

Yes, John. We discussed this on prior calls. We are trying to drive it to our overall corporate target. Depending on mix, as Fred mentioned, those businesses can perform well. We've made good progress going from losing money in ancillary to now making money. To your point, roughly four-plus percent, and if you look ex-amortization, on a cash basis it's a bit higher. We will continue focusing on bringing all those businesses together and improving them.

Our view is that the ancillary businesses will be accretive to the overall company. Our corporate goals include that they will be at least neutral and potentially helpful in the near term. We can see the path to the kind of overall company margin—nine to ten percent—that we talk about.

What you're seeing now is everything is basically origination-driven. There's a lot happening in the notary businesses and appraisal businesses. Some other businesses, for example capital markets and foreclosure search, have high margins but not a lot of activity currently. When we see a more normalized environment with transactions across each area—capital markets and foreclosure/delinquency—that should help margins further.

Okay, that is very helpful. Thank you guys.

Thank you.

And we will take our next question from Geoffrey Dunn with Dowling & Partners.

Good morning guys. Could you give us a bit of an update on the U.S. commercial market? There's talk of a strong rebound in the back half of the year. It seems some Q1 activity might have been pulled into Q4. Discuss the overall health, the mix of larger deals versus local deals, and your outlook and pipeline going into the middle of this year.

Do you want to take that, David?

Yes. Geoff, thanks for the question. I don't think our outlook has really changed from what we said before. We see commercial coming back a little slower. The sector mix has been heavy industrial; you're seeing some activity in energy and a little movement in hospitality and office. We think the market this year starts to improve a bit, but it will still be challenging. We haven't really changed our outlook from prior calls.

Yes. The business is very lumpy. Our analysis of last year showed some volatility; I don't really believe we definitively 'gained share' in commercial—some of our business got pulled into the fourth quarter. Particularly our energy business, a lot was pulled into the first quarter. It's lumpy. We are competing effectively and holding share, but it's bumpy because commercial is a smaller business for us. January and February were quite slow, and it felt like a lot of business was pulled into the fourth quarter. March was much better and April was particularly better. To David's point, our outlook for the industry is a relatively soft year. We have been holding share. If you look at the last four quarters together we will do the analysis this quarter as well. For us it's lumpy because of our size. Our average revenue per ticket was down because we didn't have a mix of large deals this quarter; the average fee per file was lower than last quarter.

Also look at the industry data—the RCA and other sources that analyze by sector and market suggest this year will be relatively soft as well. That informs our view. There could be other views specific to certain companies' client mixes, but the data is consistent with our assessment.

I want to reiterate that we've set up aggressively for commercial. We've invested a lot in commercial in the U.S., Canada and Europe. We are focusing on targeted geographies and sectors, and I feel very good about it. We've acquired talent and lined up capabilities, so as the market comes back we should be able to capitalize on it. Commercial is an important part of our future.

Okay. I also wanted to talk about tech investment. In your opening comments you mentioned automated underwriting capabilities and platforms. You invested in Notarize and NotaryCam last year to enhance digital closings. Where is your tech investment focus with respect to digitization and automation as we look into 2021 and 2022? More internal development, or targeted areas to own versus rent? I'm curious how your tech spend is directed over the next year or two.

We have a lot of the pieces pulled together and we continue to invest. We're proud of our automated underwriting work—our metrics are as good as anybody, including start-ups in the industry, and the effectiveness is strong. We're using additional data to apply underwriting to a broader array of cases, particularly in purchases, and continue investments there. On the front end, we focus on connectivity and efficiency and will continue to refine that. For Notarize and remote notary, we're productizing features, particularly for the agency channel, making products easier for agents to order and integrate into their systems. All pieces of the chain are being refined; we are continuing evolution and innovation. My view is we are ahead of adoption in the industry, but adoption will continue to increase. Customer experience must improve and we will keep investing in various parts of the chain. The larger players have an advantage because of data access, which helps apply these tools to improve experience. We're committed to continuing investment and I feel very good about our position.

Okay, thank you.

Thank you.

It appears we have no further questions at this time. I will turn the program back over to our presenters.

Well, I want to thank everybody for joining us for the first quarter, and I really appreciate your interest in Stewart. Thank you.