Motor insurers keep foot on the pedal

Oct 19 2009 by Andrew Miller, The Journal

Share Watch with Andrew Miller

ADMIRAL GROUP – We are retaining our outperform recommendation on Admiral, with a fair value of 1450p. Admiral has a simple, but very strong, underlying business model focusing on UK motor insurance.

The company is unique and leads the industry in a number of areas including their underwriting track record, flexible reinsurance agreements, and low expense ratios.

The group is highly geared to a turn in the UK motor underwriting cycle and recent company guidance suggests that the cycle is now turning.

Admiral has already established a track record of delivering strong compound annual growth at the bottom of the cycle, and the high payout ratio of circa 80% is testament to the powerful cash generation of the business.

The shares also offer an option on potential international growth. The group currently has seed operations in Spain, Germany, and Italy, with a US venture now underway.

There was some concern that sales of its 'ancillary' products – additional to the car insurance itself – might suffer in the current environment.

However, revenue per client here has remained solid, and management have provided further disclosure here, indicating that as much as two thirds of these products are non-discretionary. The past year has been difficult for Admiral’s website confused.com, where, despite its first mover advantage, intense competition and advertising spend has impacted on profits.

We remain cautious here but there have been signs that new entrants are beginning to exit and market share settle. Overall, we see the risks around ancillary income and confused.com more than counterbalanced by the growth story, both in the UK and abroad.

Prudential – We are retaining our outperform recommendation on Prudential, with an updated fair value of 780p.

Prudential shares have performed well relative to the FTSE Life insurance sector in 2009, driven mainly by a positive response to the full-year results. At the results, management announced a much stronger solvency position than expected, helped in part by the sale of the Taiwan agency business.

Prudential's IGD solvency ratio is now amongst the highest of the European large caps, and the group retains a high credit rating.

The unique Asian franchise remains the source of attraction for Prudential, and the region now produces the majority of new business and Embedded Value (EV) profits.

Although slowing, we expect growth in the region, in particular for insurance products, to be stronger than in the West. The group has been aggressively growing the Asian agency force, which should help expansion as conditions improve. There have been market concerns over the group's US division, Jackson Life, and the risks around product guarantees and hedging.

These were addressed at the interim results, and we think are overplayed, with the group increasing pricing at the expense of market share, and actually booking a profit through its hedging, at the same time as competitors encountered difficulties.

In the UK, growth prospects are limited, but the division is cash generative, as is the group's asset management division, where investment performance has been strong.

Prudential's valuation is at a slight premium to the UK life insurance sector, but we feel this is counterbalanced by the superior growth and robust solvency.

Andrew Miller is director of Barclays Wealth in Newcastle