Scotia Capital While he warns Canadian Property and Casualty (P&C) insurance companies continue to face risks across personal automobile lines, Scotia Capital analyst Phil Hardie believes “an inflection point is likely on the horizon.”
“Reduced claims inflation and the benefits of the recent premium rate increases working their way through earnings are expected to produce a growing tailwind for profitability improvements,” he said. “That said, auto theft-related claims are likely an area that will continue to see pressure. We expect Intact to reach its inflection point near the mid-point of 2023, while we expect Definity to take a few more quarters and see improvements starting in early 2024.
“We are likely in the later innings of the pricing cycle but expect the firm-to-hard markets to continue given that there are more tailwinds than headwinds. Factors putting upward pressure on pricing and likely to extend the cycle include (1) inflation, (2) severe weather, and (3) increased reinsurance costs. The emerging counter forecast involves (1) improved industry profitability, (2) new capital entering the market, and (3) the recent rise in interest rates.”
In a research report released Monday examining issues facing the sector over the next 12-18 months, Mr. Hardie emphasized the impact of ongoing M&A activity.
“Intact and Definity are likely well-capitalized and have a high degree of financial flexibility,” he said. “Given their strong appetite for M&A, we see deal activity as potential catalysts over the next 12 to 24 months. Trisura will also consider M&A to help accelerate its growth and recently noted that it is seeing more opportunities than in the past. Fairfax has recently bought and sold businesses and is likely to maintain a more “internal focus” in its M&A strategy. We believe that Fairfax will take a selective approach to M&A with an internal focus aimed at acquiring the remaining minority stakes of the businesses it already owns rather than seeking out transformative acquisitions.”
Mr. Hardie reaffirmed Fairfax Financial Holdings Inc. as his “top pick” in the sector, seeing “solid upside” despite a strong start to the year.
“We view Fairfax as an attractive opportunity with the current valuation likely not reflecting the company’s earnings power,” he said. “We believe the stock should garner a sustainable re-rate on the back of the organic expansion in its insurance operations, which likely enhances the company’s ROE and the growth rate potential of its book value, and potentially adds greater consistency to both metrics. The company is likely well positioned for the current rate environment and has locked in a much higher run-rate of operating investment income as a result of the rise in bond yields and its short-duration portfolio. Further, given its value investing approach, we think it has the potential to continue to generate outsized investment returns – even against a backdrop of more modest equity market returns. The company has demonstrated resilience through the business cycle and turbulent financial markets, but we view it as a less-defensive play than more traditional publicly listed insurers. At this stage of the market cycle, this likely provides an attractive balance: downside protection thanks to the relative resilience of insurance operations through a potential recession, and upside potential when markets recover. The company is likely overlooked or unloved by investors, and continues to trade well below its intrinsic value. We are bullish on the name and believe FFH is well-positioned to successfully navigate the current environment and remains one of our top value ideas for 2023.”
To reflect an upward revision to his book value forecast, Mr. Hardie raised his target for Fairfax shares to $1,500 from $1,350 with a “sector outperform” recommendation. The average on the Street is $1,355.08.
Conversely, he lowered his targets for the other three stocks in the sector “due to lower target multiples, reflecting some compression.” They are:
* Intact Financial Corp. (IFC-T, “sector outperform”) to $210 from $225. The average is $218.60.
Mr. Hardie: “Intact remains our ‘Go-To’ defensive quality name that we believe is attractive for large-cap investors looking for a high-quality name to reduce portfolio beta and trades at a reasonable valuation. Intact is Canada’s largest P&C insurer, with a successful long-term track record of exceeding industry ROE by 500 basis points, that is also a resilient, defensive-oriented leading financial services company with a strong management team and mid- to long-term growth prospects. The pillars of its strategic road map for growth include expanding leadership in Canada, building a specialty solutions leader, and strengthening leading positions in the United Kingdom and Ireland. We view Intact as our ‘Go-To’ defensive quality name largely from its defensive characteristics, solid growth outlook, and sustainable mid-teen ROEs supported by a favourable pricing environment. M&A also likely provides an embedded catalyst. Given its current levels of excess capital and progress with the RSA integration, we believe deal activity is imminent over the next 12 to 24 months. We see several catalysts on the horizons that include (1) stronger-than-expected underwriting and operational performance once conditions normalize, (2) demonstrated value creation and performance enhancement from the RSA UK&I platform over the mid- to longer-term, and (3) potential resumption of larger scale M&A activity.”
* Definity Financial Corp. ( “sector outperform”) to $44 from $50. The average is $42.41.
Mr. Hardie: " We view Definity as an evolutionary story, but what we believe truly sets it apart from its publicly traded peers are the themes related to excess capital and M&A, and what they mean for the ROE outlook and the stock’s valuation. We believe these are key reasons to like and own Definity: (1) defensively positioned with limited sensitivity to macroeconomic factors, interest rates, or financial markets; (2) solid growth prospects and a resilient model that is likely able to support double-digit earnings growth and compound BVPS by mid-single digits over the mid- to long-term; (3) a strong management team; and (4) M&A potential serves as an embedded catalyst, with mid-term takeout potential likely limiting downside risks. Definity has gone through a significant foundational transformation of its business over the last few years, culminating in the establishment of leading digital platforms and an overhaul of its commercial portfolio that should support competitive positioning and accelerated growth with sustained profitability. We believe that a high level of excess capital, an under-levered balance sheet, and M&A optionality can provide a path to mid-teens ROE, which could offer significant upside potential to the stock.”
* Trisura Group Ltd. ( “sector outperform”) to $53 from $55.
Mr. Hardie: “We see Trisura as an attractive high-growth business with a unique and diversified Specialty P&C insurance platform. Trisura’s unique hybrid fronting platform should enable it to generate a more consistent and capital-efficient earnings stream than traditional insurers, resulting in a superior ROE and risk profile than that of more traditional insurers. As the business continues to transform, we believe these characteristics can support a premium valuation relative to its peers. The team is targeting ROE in the mid-to-high-teens and believes that given its market focus and growth initiatives, the company will be able to sustain top-line growth in the mid-to-high-teens over the next five years. The company also reiterated its goal of targeting $1-billion of book value by the end of 2027, almost doubling from its current level of just over $500 million.”