2. Business Description
Financial Services Industry
Largest P&C insurer in Canada (7.94B Mkt Cap.)
$7.0B in direct premiums written
$12.7B in cash and invested assets
Distinct Brands:
3. As at H1-2012 H1-2011
June 30
Direct $3,356M $2,297M
Premiums 46.1% inc.
Written
9. Valuation
Valuation appears attractive at 1.88x Q3/12E
BVPS, with dividend increase expected in February
2013.
Current BVPS=$30.30
Sept.’13E BVPS=$37.65
12 mo. $75 target price, based on 2.05x Sept. ’13E
BVPS.
1 mo. RSI of 39.45 Presents immediate buy signal
I’d like to thank you for giving me the opportunity today to talk about Intact Financial Corporation, the Canadian Equity I’m recommending.
I’m not going to spend much time on the business description of Intact as it is a major player in the Canadian Financial Services industry and I’m sure all of you are very aware of their operations. They are the largest property and casualty insurer in Canada with over $7B in direct premiums written, and $12.7B in cash and invested assets. They have 5 major distinct brands: Intact, Belairdirect, Grey Power, Jevco, and AXA Canada. Jevco and AXA are recent acquisitions both finalized in September 2012. I will point out that unless otherwise notified the numbers in this presentation are as of Q2 June 30, 2012.
A further breakdown of Intact’s business mix shows a heavy representation in personal auto insurance, and a growing representation in commercial insurance. Commercial insurance generates larger premiums, which can be attributed to Intact’s 46% year over year increase in revenue from direct written premiums. On the right hand side I have compared Intact to the Top 20 property and casualty insurers in the market and as you can see Intact steadily outperforms. Their combined ratio is 1.5 basis points better than the Top 20 average, and their ROE is 5.2bp better. At the bottom I have provided the company’s value chain or operations that warrant a competitive advantage.
An integral part of any large cap insurance company is their asset management, and Intact insurance posses a very stable income generating portfolio. Intact has $12.7B in cash and invested assets, with a very conservative allocation model. This helps the company generate steady low-risk return on capital. The portfolio is 73% Fixed income with high quality bonds, as you can see the breakdown there. Intact has very little U.S. and European exposure which contribute to the low-risk return model. Intact far surpasses the Minimum Capital Test at 205% with an industry standard of 150% and the bear minimum being 100%. Their BVPS increased 13% YOY, currently valuing Intact at a little more than 2xBVPS. I will talk more about this when I get to my valuation and target price for the stock.
Recent weakness represents a buying opportunity – underperforming U.S. peers. Since the fall of 2011, IFC traded in line with its U.S. peers until it reported its Q2/12 results on August 1, 2012. Since then, IFC has underperformed its U.S. peers by close to 15%, as shown in Exhibit 1. BMO Capital Markets believe investors are perhaps focusing on the company’s slightly higher catastrophe losses in Q2/12 and the September 5 pre-announced catastrophe hit from summer storms ($0.85–1.00 EPS).
Recent weakness represents a buying opportunity – IFC valuations historically tend to be more appealing after storm-related dips. The company has pre-announced catastrophe hits twice before, one in October 2009 for some summer storms and the other in May 2011 for the Slave Lake fires, and in both cases over the following three and six months IFC significantly outperformed the S&P/TSX and its U.S. peers (see Exhibit 2). Also, BMO Capital Markets notes that weather- related claims are generally not indicative of any significant change in industry fundamentals, and, if anything, have tended to result in some price firming.
IFC’s underwriting profitability continues to improve. Exhibit 3 shows that accident year (removes the impact of prior period reserve development, either favourable or unfavourable) combined ratios (ex cat losses), which I believe to be a good measure of underlying underwriting profitability, continue to decline y/y. This clearly points to continued improving underwriting profitability. I believe this is a testament to IFC’s underwriting expertise as well as its size advantage (bigger is better in terms of better pricing and hence better underwriting, as well as to some extent a lower operating expense ratio), as well as to some extent modestly improving underwriting from an industry perspective, especially with respect to Ontario auto since reforms were put into place September 2010. The increase in the combined ratio for the commercial segment in 2012 is attributable to an unusually high level of large losses in Q1/12 and as an increase in ceded reinsurance. IFC’s commercial P&C insurance segment had an accident year ex cats combined ratio of 96.6%, better than the 97.4% in Q2/11.
I believe IFC continues to be a great GARP story with very good defensive characteristics and improving industry and company fundamentals. Additional potential catalysts include better upside potential from recent acquisitions (increased scale and supply chain benefits), continued price hikes, firming markets, top-line momentum, and perhaps a 10% dividend hike concurrent with Q4/12 results.
IFC is well below historical valuation levels compared to its U.S. peers – it is currently sitting at a 13% discount to its U.S. peers on a P/BV vs. 2013E operating ROE basis, compared to a historical 11% premium. And, given that our 2013E operating ROE of 19.5% implies a 2.33x P/BV multiple (based on regression shown in Exhibit 9), and that we expect BVPS to grow from $30.30 in Q2/12 to $37.65 by the end of 2013 (helped by $6.60 2013 Op EPS and 2.3% BVPS accretion from Jevco deal), we see valuation upside. On a P/E (operating) basis, IFC appears attractive as well, trading at 8.9x 2013E operating EPS versus its U.S. peers at 11.5x. Also, we expect the company will raise its dividend (it has increased it every year since its 2004 IPO) by 10% when it reports Q4/12 results (likely early February 2013).
