This week we conclude our latest Talking Top Twenty series, working our way through a couple of insurance companies, Insurance Australia Group (IAG.ASX) and Suncorp (SUN.ASX).
Talking Top Twenty: Commonwealth Bank (CBA.ASX) & Westpac (WBC.ASX)
Talking Top Twenty: National Australia Bank (NAB.ASX) & ANZ (ANZ.ASX)
Talking Top Twenty: BHP (BHP.ASX) & Fortescue (FMG.ASX)
Talking Top Twenty: Rio Tinto (RIO.ASX), Woodside (WPL.ASX) & Newcrest (NCM.ASX)
Talking Top Twenty: CSL (CSL.ASX), Wesfarmers (WES.ASX) & Woolworths (WOW.ASX)
Talking Top Twenty: Macquarie Group (MQG.ASX) & Telstra Corporation (TLS.ASX)
Talking Top Twenty: Transurban (TCL.ASX) & Goodman Group (GMG.ASX)
Insurance Australia Group Ltd (IAG.ASX)
When we last wrote about this particular business we suggested that, as with the insurance industry more broadly, it remains a work in progress. This has apparently been reflected in the share price since, i.e. broadly tracking sideways. Looking at firm specific factors, we continue to grow more comfortable with the ability of the team led by Mr Hawkins in navigating a rather messy outlook, insurance and reinsurance being particularly commoditised products that have historically seen margin pressure. At this stage the more aggressive stance by the RBA on policy should offer some tailwinds for investment income, the group having more than AU $12bn in investable assets at the time of writing. Assuming a yield of 1.85%, this represents around AU $209m in investment income. That accounts for around 26% of pre-tax income. Should aggressive monetary policy continue both in Australia and globally, this could represent a significant tailwind. To illustrate, let’s assume a reasonable yield number of around 5% over the next 3-5 years then then this pre-tax impact could materially change the business’ profitability (i.e. investment income increasing to around 40% of pre-tax profit).
The big risks are things largely outside the business’ control though, including the likes of weather events (a controversial subject for some given that this has been linked to climate change). In fact, the recent messiness in numbers (and price action) can largely be attributed to rainfall across the East coast. We think the business will be able to recoup the costs however. With all that in mind, let us get to the actual numbers.
There are signs the turnaround remains on track with Gross Written Potential (GWP) continuing its upward momentum, increasing +6.2%. Interestingly, underlying margins have increased to 15.1% for 1H22. A rather surprising turn of events given that the previous number was approximately 15% (which we attributed to things like a lack of auto claims during Covid lockdowns). Should we see premiums at least keep up with inflation, we think that this may just be a great result for shareholders.
Red Flags & Risks: From a risk perspective, CET1 continues to stand well above requirements although the multiple has declined substantially from 1.19 to 1.02, or 17pts. Continued outsized impact from weather events and changes to the environment are arguably the biggest long term risk while any delays to rate normalisation (at least on a historic basis) still remains a substantial risk (despite recent headlines suggesting otherwise).
Expectations: This continues to be reflation trade and, while insurance remains a messy sector, we think it has now become a reasonable buy given the current price. Our fair value remains at $6.50 assuming a 13x earnings multiple for the coming year.
Dividend Yield: The yield now stands at a stellar 4.2% assuming a share price of $4.68 (we estimate the DPS at 20c).
Suncorp Group Ltd (SUN.ASX)
Broadly speaking, our view around Suncorp is similar to that of IAG. We do like the current streamlining and the discipline in the balance sheet following the sale of the life insurance business. This is basically a reflation trade with the caveat that it sells and operates a heavily commoditised product line and, although the Suncorp banking arm remains profitable and has shown strong momentum in recent quarters, the bread and butter is still the insurance business with margins and profitability effectively being a function of cost-outs. The increasing frequency of natural hazards, as mentioned above, likely to put upward pressure on reinsurance costs.
That said, the recent reversal in monetary policy outlook combined with premium increases should deliver steady increases to cashflows and overall profitability. The demerger or sale of Suncorp Bank still remains on the table but could potentially be a negative in our view. The flip side of the current market environment is that the division is unlikely to receive a significant enough premium to deliver value to shareholders. Taking that potential red flag away however, we think that management has continued to deliver on its strategy streamlining the overall business.
Getting to the numbers, it has been a rather messy scenario. Group NPAT for 1H22 came in at AU $388m (compared to $490m in 1H21) and cash earnings at $361m (compared to $509m in 1H21). While this may seem less than pleasing, this is likely a function of the outsized natural events beyond management control; natural hazard claims amounting to around AU $205m above the forecast allowance. Assuming we don’t see continued headwinds on this front and that 2H21 was indeed an abnormal year, we should see some better quarters ahead. GWP continues to increase at a pleasing pace at about +7.5% in Australia while NZ is maintaining momentum at a double digit +14%. This, combined with increased returns in terms of investment income, should offer some tailwinds to the business.
The key going forward is execution on the bancassurance model, where cross-selling and upselling takes place as well as driving increased customer stickiness. For example, selling a home insurance policy alongside a mortgage with incentives to bundle the two together.
Red Flags & Risks: In our view, the biggest red flag was the increase in the payout ratio at the cost of CET1. We think the business would have been better off retaining capital and may have been better off lowering the dividend yield (even at the cost of antagonising longstanding shareholders). Natural hazard claims and their increased frequency could place greater pressure on earnings visibility and overall risk.
Expectations: The business is well capitalised and rather cheap but we still remain of the view that IAG offers a “cheaper” proposition. The business does present as a decent dividend play though.
Dividend Yield: 5.18% assuming a share price of AU $11.08.
Disclaimer: IAG and SUN are currently held in TAMIM individually managed account (IMA) portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.