Under the Radar: IPC Soars Amid Clear Skies

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HAMILTON, Bermuda (TheStreet) -- Understanding the risks of reinsurance, which insurers buy to shield themselves from catastrophic losses, requires geological and meteorological expertise. But from an investing perspective, it's easy to see why IPC Holdings(IPCR) is a small-cap reinsurer with big growth potential.

The company's second-quarter net income rocketed 266% to $174 million, or $3.11 a share, as revenue surged 240% to $195 million. Its profit spreads are even more impressive, with net, operating and gross margins of 88% to 99%.

So how is IPC putting up these numbers? Around 80% of the gross premiums it collects cover catastrophe risks, such as earthquakes, hurricanes, tornados, floods and volcanic eruptions. It compensates its clients only if a natural disaster hits.

This business model relies on the efficient management of geographic and numeric risk. You reap massive profits when everything is going smoothly. But a 100-year flood can deplete cash fast. Still, IPC is extremely well-capitalized and has a balance sheet that outshines those of its peers, with $272 million of cash and no debt.

IPC is rated A-minus by Standard and Poor's. Our stock-rating model gives the company a financial strength score of 9.9 out of 10, higher than our "buy"-rated average of 7 and our insurance industry average of 6.5.

Surprisingly, the stock is cheap compared to the rest of the industry. Its shares trade at a price-to-earnings ratio of 14, a 77% discount to its peers and "buy"-rated large-caps such as Aon(AOC) and Travelers(TRV). The stock's price-to-earnings ratio for 2010 is 6, a vast discount to the market.