Most investors get to hear about analyst upgrades and new Buy ratings, but they often do not get to hear about the analyst downgrades. This makes it harder and harder to know when to a sell a stock. After all, buying and holding forever can come with serious pain if a stock never gets sold.
Thursday morning brought two key financial downgrades from Merrill Lynch. The firm downgraded Unum Group (NYSE: UNM) and Travelers Companies Inc. (NYSE: TRV) to Neutral from Buy. Both stocks are seen with limited upside, and investors should remember that Travelers is often forgotten about as a member of the Dow Jones Industrial Average.
24/7 Wall St. wanted to see what was driving these downgrades. After all, analyst downgrades are rarely covered in depth like many of the great Buy-rated ideas.
Travelers was downgraded to Neutral based on valuation. The stock has risen by 16% in the past quarter and the firm sees a total return potential for the shares of only 5.8%. The firm’s $120 price objective actually was raised by $2.00 from the old price target, but that is based on a multiple on the estimated year-ahead book value per share of 1.4 times.
The Merrill Lynch team said:
Our $120 price objective is based on valuation of 1.4x the estimated year-ahead book value. This multiple is supported by an expected ROE of about 12% for the next two years, comfortably above Traveler’s equity cost of capital. On a P/E basis, our price objective suggests a multiple of 11.5x our 2017 estimate. While this multiple is a material discount to the S&P 500, we expected minimal EPS growth at Travelers and the potential volatility in earnings is higher than the markets given the impact of weather.
Merrill Lynch sees risks to Travelers. Those are the departure of any key management, a resurgence of asbestos or environmental claims, a more hostile stance by state insurance commissioners and a spike in the frequency or severity of insurance claims. Additional risks noted were potential future acquisition activity, increased losses in the surety line, a more dramatic deterioration in the credit environment, poor results in alternative investments and more intense competitive conditions than are expecting.
Unum was downgraded to Neutral and the price objective of $39 implies a total return (including the dividend) of 8% — under the 13% average implied upside for the group and under the 18% average implied upside for the firm’s Buy-rated stocks.
The team sees long-term care closed block remains a primary limitation, and it sees positive ongoing business trends. Unfortunately the firm sees few catalysts for a reason to own the stock. Merrill Lynch’s report said:
We are downgrading Unum to Neutral as Unum now trades at a significant premium to traditional U.S. life peers (Lincoln, MetLife, Prudential). Unum’s core group business is attractive, but the overhang from the legacy long-term-care segment is unlikely to lift. We anticipate a fairly positive update to the core businesses at the 12/17 investor day, but expect no specific catalyst.
Again, investors are told often about the need and upside of buying stocks. They just do not get to hear when it is time to sell. A downgrade to Neutral may not be a screaming Sell rating (Merrill Lynch has “Underperform” as its own label for Sell ratings). Still, they see limited upside from here in these companies.
Travelers was last seen down 1.8% to $112.66, against a 52-week range of $95.21 to $116.48. It has a consensus analyst price target of $111.10.
Unum Group was last seen down 1%, at $36.38 in a 52-week range of $29.81 to $38.15. The consensus price target is $39.00.