Scotia Capital Raises Targets While Canadian-listed property and casualty insurance stocks have delivered “solid outperformance,” Scotia Capital analyst Phil Hardie remain bullish and see further upside potential.
“We believe the P&C insurers look well positioned for the year ahead,” he said in a report. “These stocks have relatively low sensitivity to macro factors and can generate solid investor returns in an environment where broad market multiple expansion is limited. Over the past year, elevated cat losses and rising rates created headwinds to book value growth for several insurers. We expect these pressures to diminish with book value growth accelerating.
“Operating ROE expansion is expected to be a common theme across our coverage of the P&C insurers. The key drivers are likely to be (1) growth in operating investment income (ex-gains) given the expansion of investment income through 2023, and (2) expanded underwriting margins. Key factors likely to drive the improvements in underwriting include: more normalized cat losses, benefits from recent pricing actions, and stabilized claims inflation rates.”
Ahead of earnings season in the quarter, Mr. Hardie thinks valuation has “likely emerged as investors’ focal point following a strong stock rally.”
“We believe the recent multiple expansion reflects an improved ROE outlook rather than a broader market or sector re-rate driven by sentiment. Investors may be surprised that the current estimated ROE vs P/B regression curve is flatter than the historical average implying that market multiples reflect a modest discount,” he said. “We estimate that all else being equal, current valuation levels are similar to those last seen in 2018 and 2019.
“We believe the pricing environment remains healthy but expect to see greater divergence across business lines. The last few years have seen a favourable pricing environment that has enabled a large portion of the P&C industry to increase rates to help drive “pricing adequacy” and improved profitability. We expect the pace of industry-wide rate increases to moderate in 2024, reflecting what we believe has become a relatively constructive operating environment with healthy margins and anticipated returns on capital. Broadly speaking, we expect firm markets to persist but believe there will be a rising level of divergence within commercial lines.”
After adjusting his estimates, Mr. Hardie raised his targets for stocks in the group while reaffirming his “sector outperform” recommendations for each.
“Fairfax and Trisura stocks have delivered over 20-per-cent upside year-to-date and remain our top picks across our overall coverage universe of Diversified Financials and P&C Insurance,” he said.
His changes are:
* Definity Financial Corp. ) to $51 from $49. The average on the Street is $47.27.
Analyst: “We believe Definity is an attractive evolutionary growth story. We view Definity as an evolutionary story, but what we believe truly sets it apart from its publicly traded peers is the themes related to excess capital and M&A and what they mean for the ROE outlook and the stock’s valuation. Reasons to like and own Definity include: (1) defensively positioned with limited sensitivity to macroeconomic factors such as interest rates, or financial markets cycle; (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-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, offering significant upside potential to the stock.”
* Fairfax Financial Holdings Ltd. to $2,000 from $1,900. Average: $1,828.09.
Analyst: “We believe Fairfax’s current valuation does not fully reflect the company’s earnings potential and remains an attractive opportunity for investors. 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. We believe the company is overlooked or unloved by investors, and continues to trade well below its intrinsic value. We are bullish on the name and believe Fairfax is well positioned to successfully navigate the current environment and remains one of our top ideas for 2024. Fairfax’s valuation discount remains wide despite showing strong growth and enhanced ROE potential.”
* Intact Financial Corp. to $261 from $256. Average: $236.19.
Analyst: “A ‘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. It is also a resilient, defensive-oriented leading financial services company with a strong management team and appealing 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 remain constructive on Intact in the current market environment, given its defensive characteristics, solid growth outlook, and sustainable mid-teens ROE supported by the 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 further deal activity is imminent over the next 12 to 24 months. We see several catalysts on the horizon 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. IFC trades at nearly 2.7 times book value, which we believe is reasonable given its ROE outlook and embedded optionality provided by its excess capital.”
* Trisura Group Ltd. to $59 from $56. Average: $54.50.
Analyst: “A unique and diversified Specialty P&C insurance platform that is a high-growth business with an attractive risk profile. 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 mid-term. The company also reiterated its goal of targeting $1-billion of book value by the end of 2027. This is up over 60 per cent from its Q4/23 book value of $620-million. The company’s vision is to be the leading specialty insurer in North America, and it has a number of growth levers.”