National Bank National Bank Financial analyst Jaeme Gloyn thinks “underlying strength” will continue to drive outperformance for Canadian Property and Casualty Insurance companies through a third-quarter earnings season season that he expects to be “solid.”
“While our P&C insurance coverage year-to-date share price performance is mixed, the sector continues to outperform the index,” he said. “Fairfax Financial Holdings Ltd. leads the group at up 46 per cent, followed by Intact Financial Corp. (up 1 per cent), Definity Financial Corp. (flat) and Trisura Group Ltd. (down 33 per cent), on average outperforming the TSX Financials Index (down 9 per cent year-to-date).”
“For our top pick FFH, we expect higher interest rates will continue to drive recurring interest and dividend income higher. We also expect strong underwriting profitability in a quarter when peers are more heavily impacted by catastrophes. While elevated catastrophe activity will impair headline results for IFC and DFY, we expect another quarter of strong top-line growth and underlying profitability (i.e., excluding catastrophes) that suggests the battle against inflation is shifting in favour of the insurers. Both will also benefit from favourable trends in non-underwriting income streams: i.e., i) steadily increasing net investment income, and ii) growing distribution income. Lastly, TSU prereleased what appears to be a clean quarter of growth and profitability that should set the stock on a valuation re-rate path towards U.S. specialty insurance peers.”
In a research report released Wednesday, Mr. Gloyn said the sector remains “well positioned” for the near term, pointing to “hard market condition and higher interest rates that support improved investment income (in particular for FFH).”
“We believe pricing trends will continue to outpace loss cost trends overall, especially for Personal Auto lines that management teams suggested in Q2-23 earnings calls were approaching an inflection point,” he added. “Moreover, we expect the elevated catastrophe activity in Personal Property lines this year to support a further hardening of conditions in that segment. In addition, we see continued strong momentum in U.S. specialty lines markets. Layering in potential M&A catalysts amplifies a strong set-up for P&C Insurance heading into 2024. On the other hand, increasing vehicle theft, elevated catastrophe activity and inflationary pressures could persist.”
From the investor perspective, he reiterated his view that “there’s something for everyone” ahead of earnings season.
“FFH remains the best value idea in our coverage,” he said. “FFH offers large-cap investors strong topline growth, underwriting profitability, and leverage to a higher interest rate environment that supports consistent mid-teen ROE for the foreseeable future. TSU offers small-cap investors a rapid growth outlook but also an attractive value play with upside to specialty insurance peer valuations as the company successfully recovers from an early 2023 misstep. We believe DFY shares offer good value to mid-cap investors as the company executes a long-term ROE expansion story with imminent M&A catalysts. IFC is the premium P&C insurer in Canada with a solid track record of growth, profitability, and M&A upside. However, IFC offers less valuation upside than its peers.
“In summary, while we encourage investors to own any one of these P&C insurers, our pecking order is FFH, TSU, DFY and IFC.”
Mr. Gloyn raised his target for shares of Fairfax Financial to $1,800 from $1,700, keeping an “outperform” rating. The average on the Street is $1,485.09, according to Refinitiv data.
“We believe FFH can deliver mid-teens ROE over the medium-term through a combination of consistently strong underwriting growth/profits and improving total investment return performance, particularly in a higher interest rate environment,” he said.
He maintained his targets and recommendations for the remainder of his coverage universe. They are:
* Trisura Group with a $58 target and “outperform” rating. Average: $52.17.
Analyst: “TSU takes second position in our P&C pecking order given a rapid growth outlook and valuation upside. In addition, we believe TSU will continue to produce solid and ‘clean’ quarters that put risks to the Q4-22 write-down and industry noise in the rear-view mirror. We view growth as de-risked given 1) persistent sector tailwinds (e.g., hard markets, high interest rate environment), 2) fee-based income drives 40 per cent of earnings, 3) lowrisk organic growth strategies (e.g., entry into U.S. surety/commercial lines and fronting admitted lines) benefiting from secular trends in U.S. MGA markets and growing Canadian distribution relationships, and 4) balance sheet capacity to execute organic growth.”
* Definity Financial with a $53 target and “outperform” rating. Average: $42.95.
Analyst: “DFY remains a land grab story with an ROE expansion kicker. We apply a target multiple of 2.1 times (unchanged) on our Q3-24 (was Q2-24) BVPS [book value per share] (plus approximately 1 times AOCI) to arrive at our $53 price target (unchanged). Our target multiple is above the current trading multiple of 1.6 times to reflect our view that i) the ROE expansion and growth story are tracking well on both organic and M&A fronts, ii) solid broker acquisitions that set the table for future organic and inorganic growth opportunities, iii) the Personal Auto business is at a positive inflection point, and iv) Personal Property and Commercial will maintain solid growth and profitability despite recently elevated catastrophe impacts.”
* Intact Financial with a $225 target and “outperform” rating. Average: $220.17.
Analyst: “IFC continues to merit a premium valuation as we expect the company will continue to produce double-digit NOIPS [net operating income per share] growth and roughly mid-teens OROE over the medium-term. Like DFY above, we believe Personal Auto has reached a positive inflection point. Persistent hard market conditions elsewhere in the business also increase the likelihood IFC will deliver earnings outperformance in the near term. For context, IFC delivered total company combined ratio of 95 per cent in 2018 and 2019 compared to 89 per cent in 2020 and 2021. We forecast 95 per cent for the full-year 2023, followed by 92 per cent through 2024, which we believe is reasonable given recent performance in hard market conditions. Separately, as Intact continues to successfully integrate RSA and the recent tuck-in of Direct Line’s commercial business, we believe the company can pursue further M&A (including large-scale M&A like Aviva Canada). That said, acquisition speculation of this magnitude could dampen near-term upside as investors await an update.”