DEFINITY FINANCIAL CORP.
Challenge
Our Conclusion
We view the Q3 update as positive based on the increase in guidance for
investment income, strong commercial lines results, solid underlying trends
for personal property (ex. CAT losses), and confirmation that the legislative
process for CBCA conversion should be complete soon. There were a lot of
questions related to Alberta rate caps for personal auto insurance. A wider
lens view shows that rate increases across the entire auto book should
contribute significant margin improvement in 2024, even if Alberta is not a
part of that. We are positive on the 2024 outlook based on strong premium
growth, margin improvement in personal auto, and growth in investment
income. Our price target increases from $40.50 to $42.50. Outperformer.
Key Points
Investment Income drives earnings upside. Q3 investment income was
4% higher than our forecast and management increased 2023 guidance from
>$160MM to ~$170MM. The book yield of the portfolio is 4% versus a market
yield of 5%, implying potential investment income of $214MM at current
yields. We forecast investment income of $192MM for 2024 (+9% Y/Y).
Personal auto should contribute higher income next year despite
Alberta challenges. We think too much has been made of the proposed
Alberta rate cap. Yes, it is a strategic setback for Sonnet, but that business is
not contributing any underwriting income. For the entire auto book, written
rates were up 13%-14% Y/Y and earned rates were up 6.5%. Claims inflation
is running around 6%-7%, which means there is potential for significant
margin expansion in 2024. Every 1 point change in the personal auto
combined ratio impacts 2024E EPS by nearly 2%.
The commercial lines buildout is humming. Commercial lines are
exceeding expectations with a YTD combined ratio of 87% and premium
growth of 16%, generating an additional $33MM of underwriting income.
Every $10MM of underwriting income adds ~2% to our 2024E. Commercial
is driving material earnings growth.
Underlying trends in personal property are strong. Significant CAT
losses this quarter masked strong underlying trends. Ex. CAT losses, the
combined ratio was down nearly 7 points Y/Y and premium growth was 12%
Y/Y. A normalized combined ratio should be around 95%, implying that 10%
premium growth adds ~$5MM to annual underwriting income (+1% EPS).
Excess capital remains an important part of the story. DFY reported
excess financial capacity of $586MM as of Q3. The Drayden acquisition will
reduce that by ~$200MM, and conversion to a business corporation (CBCA),
which is expected soon, should add roughly $600MM. Net-net, that means
DFY has roughly $1B of excess capital for organic growth and acquisitions