CNA Surety Corp.

On Friday, CNA Surety Corp. (SUR) was down nearly 6%. Also, this was the fifth consecutive down week for SUR, having fallen 28% in the past 28 trading days. SUR is a company that writes surety and fidelity bonds and was the 3rd largest surety writer in the U.S. in 2007, having about 8% of the total market.

The Good

SUR is a consistently profitable writer of insurance. It’s had a combined ratio of 73.2%, 78.5%, 79.3%, 94.8%, and 92.7%, respectively for 2008, 2007, 2006, 2005, and 2004. SUR also had another record year for net income in 2008, earning $110 million. Some various other ratios to keep in mind is that SUR is now trading below its book value with a P/B ratio of 0.8. It’s also trading at 4.74 times free cash flow (that’s a a big cash flow yield of about 21%) and at 5.8 times earnings (an earnings yield of about 17.2%).  These yields are a LOT better than the current S&P earnings yield (6.15%) and 30-year treasury yields (4.06%). Based on the cursory data above, I think SUR would be a great buy. But one must also consider the risks. The following risks are the most obvious to me.

Some Things To Keep in Mind

One thing to keep in mind is that about 62% of SUR’s common stock is owned by CNA Financial Corp (CNA), which is not really a risk, but just something to keep in mind. The reason why this might be a good thing is that I have heard occasional talk of how CNA would like to acquire the rest of SUR’s shares. It was back in 2000 that CNA, through one of its subsidiaries, made a tender offer to acquire the rest of SUR’s shares. Another thing to keep in mind is that the vast majority of the demand for SUR’s products result from federal, state, and local laws that mandate the use of surety bonds. I see this mainly as a good thing as this guarantees a market. For example, if you are applying to become a mortgage broker in the state of Georgia, the Department of Banking and Finance requires that you submit a bond to them prior to receiving a license. I seriously doubt any government will cease to require surety bonds. And in connection with the stimulus package, SUR will be a beneficiary of any spending on infrastructure. The most serious factor to consider is that a significant portion of SUR’s business is guaranteeing the performance of construction firms, which means they can be affected by any challenges the construction industry faces. In fact, Willis Group has a recent report suggesting that the surety industry is “on the verge of a loss cycle and, possibly, a severe one.” At the very least I think SUR presents a good trading opportunity if you happen to be a trader… And despite an oncoming and possibly severe loss cycle, SUR might very well be a good purchase for the long-term investor at this price level. If you look at the past ten years, SUR has traded at around 1.3 times its book value — if SUR regains that historical average, that would mean a price of about $23.4, an approximate 65% gain from its current price. As always, do your own due diligence.