What you should know before investing in Heritage Insurance Holdings

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Heritage InsuranceSometimes a better story is about a stock you decided NOT to buy. Such is my tale of Heritage Insurance Holdings (Ticker: HRTG). I recently began my initial analysis of Heritage Insurance after it landed on one of my growth and value screens.

The stock is currently trading at a P/E of 11.56 and has experienced revenue growth of 87%, 69%, and 11% the past three years. The combined ratio, which is an important indicator of profitability for insurers, has averaged 75% since the company went public which is actually very good.

My interest was piqued until I discovered something about the company’s management that made this stock simply impossible to invest in despite the company’s performance and valuation.

The CEO had total compensation of $27,263,997 in 2015! That is more than the CEO of JPMorgan Chase ($18.2m) or Goldman Sachs ($22.6m).

How is it possible for the CEO of a $383 million market cap company to be paid the equivalent of 7% of the company’s market value?

About Heritage Insurance

Heritage is a home, condo, and rental insurer that has been siphoning off policies from the Florida state-run Citizens Property Insurance Corporation. The State of Florida decided it would be best to reduce their risk through a reduction in the number of policies on Citizens’ books and have private companies step in to take on that risk. Thus, Heritage Insurance was born and has “assumed” policies from Citizens to the tune of about 53% of their total policies on the books as of December 2016.

Things seemed to be going well for them until Hurricane Hermine became the first hurricane to make landfall in Florida in over 10 years. Luckily, Hermine did not materially affect the company as only $3 million in losses were incurred.

Hurricane Matthew, on the other hand, become a much stronger storm reaching category 5 strength. At one point it looked like Matthew would make a direct landfall in south Florida but the storm tracked along the coast sparing much of the state the widespread devastation that could have been caused. Losses from Matthew totaled $18.8 million which was substantially more than Hermine.

As a reminder, the CEO was paid total compensation of $27 million or the equivalent of 1.44 Hurricane Matthews.

Heritage Insurance 2016 Results

Yesterday, Heritage reported a net loss for the fourth quarter of $2.9 million and net income for the full year of $33.9 million. They also managed to buy back $25.6 million worth of stock during the year at an average price of $14.49. The stock is trading below that level now.

In addition to the buybacks, the company paid $6.8 million in dividends to shareholders. That is a total of $32.4 million returned to shareholders or about  96% of net income.

The CEO was paid $27 million or 83% of the total shareholder payout of $32.4 million. 

Heritage Insurance CEO Compensation Package

The juicy compensation details for corporate executives can be found in the company’s proxy statement. It is one of my favorite financial documents to read because of some of the absurd deals that are made.

This is not a rant against the CEO. He has clearly done a tremendous job of marketing his value to convince the board he is worth this much money. The local media has already blasted him several times here and here but their angst is misguided by focusing on CEO Bruce Lucas rather than the poor oversight of the board.

Lucas received a salary of $750,000, a bonus of $10,430,940, and stock awards of $16,050,000.

Heritage Insurance Proxy

 

Source: Heritage Insurance Holdings Proxy Statement Schedule 14A  (4/27/16)

The proxy statement expands on Lucas’ employment agreement and explains that the stock awards will be vested over a 5 year period. This is more like a signing bonus athletes receive when they sign a new contract as a free agent.

Effective November 4, 2015, Mr. Lucas entered into an amended and restated employment agreement (the “Lucas Amended Agreement”) with us to serve as our Chief Executive Officer until December 31, 2020. The Lucas Amended Agreement provides for (i) an annual base salary of $2.0 million commencing on January 1, 2016 (subject to annual cost of living and inflation-based adjustments), (ii) an incentive bonus under the Heritage Insurance Holdings, Inc. Omnibus Incentive Plan (the “ Omnibus Plan”) of $1.75 million for each calendar year, beginning in 2016, subject to the Company’s achievement of at least $50 million in EBITDA for such year and (iii) an annual cash bonus under the Company’s EBITDA bonus pool with a target amount equal to the greater of (A) $2.5 million or (B) the remainder of the Company’s bonus pool after paying all employee bonuses. In connection with the Lucas Amended Agreement, Mr. Lucas received a grant of 750,000 shares of restricted stock, which vest in equal annual installments of 150,000 shares beginning on November 4, 2016.

This agreement comes with all the usual features such as full payment if the board fires him without “cause” or if he were to die his estate would receive 50% of his base salary for the 5 year term.

Conclusion

While CEO and executive pay remains a topic of hot debate, the generous compensation package Heritage’s board has given their CEO is out of line given the size and short history of the company’s performance. This is simply not a board I would trust with my money.

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