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Admiral Group Plc Full Year Update – 25 March 2015

Company Overview:

Admiral Group Plc is the UK’s leading motor insurer and has been listed since 2004 on the FTSE 100 index of the London Stock Exchange. Its primary line of business is motor insurance although the group also draws substantial revenues from the sale of ancillary services such as breakdown cover.

Today the group operates 14 brands worldwide and employs 7,000 members across the globe, with 2,900 of these based in the group’s Cardiff head offices.  In 2013 the group insured 3.7 million vehicles and reported revenues in excess of £2 billion.

Brands include: Admiral, Elephant, Diamond, Bell, Confused.com, Gladiator and 11 others.

Index FTSE 100 Ticker ADML.L Latest Close 1,526.00
52 Week High 1,583.00 52 Week Low 1,175.00 P/E 15.78
Dividend Yield % 6.4 Dividend Cover 1 CEO: Henry Engelhardt
CFO: Geraint Jones Previous Price Target 1,350.00 Current Price Target 1,350.00


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Admiral shares rebound sharply in Q4 through to Q1, full year results surprise on the upside

At the time of our last update we lowered our price target for Admiral Group moderately before reiterating our positive longer term outlook for the shares.

Our key concerns at the time were management’s dovishness over future margins due to it having engaged in the race to the bottom with premium rates during earlier periods, which had led to a heightened degree of concern among the board over the future outlook for earnings at the group.

This update came on the back of a sustained period of weakness for the shares where investors had responded en masse to a darkening outlook for the industry and a host of downgrades from the analyst community.

However, since this time, investors appear to have deemed the summer time sell off in the shares excessive and subsequently afforded the benefit of doubt to Admiral, which has now driven a nascent  recovery in the share price.

This saw ADM.L hit our revised price target of 1,350.00 pence in January of the new year, a move which preceded further gains that came on the back of a full year results announcement detailing a much lesser than expected decline in earnings for the period.

In addition to this, the group reported that its Italian operation made its first ever full year underwriting profit in 2014, while management now expect that the Spanish insurance operation will also record its first ever underwriting profit in 2015.

However, and despite the surprise on the upside in terms of financial numbers, the risks to earnings at Admiral in 2015 are still finely balanced, while a large portion of the analyst community also maintains negative guidance for the shares.

Below we provide a more detailed overview of Admiral’s full year performance, before outlining our own expectations for the group going forward and explaining why we have maintained our price target for the shares at 1,350.00 pence today.

Admiral Group Plc Share Price / 8 Hour Intervals

ADMIRALGROUPENDMARCH

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Full year results overview

At the group level Admiral reported a 3% decline in turnover for the period, which was mostly the result of a fall in the average UK motor insurance premium for the full year, despite an upturn in divisional premium rates in the second half.

This led contributed to a 4% fall in group pre tax profit for the full year, although a significant increase of investment in the US price comparison business compare.com also made a considerable contribution to here.

The decline in pre tax profits was later softened by a lower corporate tax rate, due in part to interest payments made on the £200 million bond issue in the summer, which meant that EPS for the period was only 2% lower at 103.0 pence.

This enabled management to keep the dividend at a largely similar level to the year before (-1%), with the total payment for 2014 being 98.4 pence, which still provides investors with an attractive yield of 6.4% at current prices.

Despite lower profits for the period, the group combined ratio also fell during the year from 89.1% in 2013 down to 88.7% during 2014, which helps to cement Admiral in its position as an industry leader in terms of operational costs and underwriting losses.

 

Divisional breakdown and overview

At the divisional level most businesses performed well during the year, although in the UK intense competition meant that profits only grew by 1%, despite a 6% uplift in the total number of vehicles insured.

Price comparison in France and Spain, Rastreator and LeLynx, have continued to perform well with each experiencing strong growth during 2014. However, price comparison in the UK has become more challenging, with Confused.com experiencing increased competition which has inevitably impacted upon the unit’s profitability.

In the US, the group’s motor insurance continues to offer promise for future years, some of which will be capitalised upon in 2015 through increased investment in the price comparison platform Compare.com

On the whole, three out of the group’s seven new international businesses now contribute positively to Admiral’s full year financial result, while even those that are still loss making appear to be improving all of the time.

 

Challenges ahead for Admiral Group and the motor insurance industry

The number one concern of management at Admiral for the year ahead is the behaviour of competitors surrounding pricing.

As has been frequently pointed out, insurance is a liability driven business where the true extent of profits and losses of any given period are only realised over the longer term, i.e at the expiration of premiums written.

Therefore, with market wide averages for premium rates having fallen to levels that make profitability difficult, the predominant and justified fear among the board is that if the race to the bottom continues, earnings across the industry could suffer greatly at a later date.

While the deceleration in premium rates has shown signs of slowing and reversal during recent quarters, out of consideration for future profitability and for the sake of prudence, Admiral began to raise its own premium rates during the latter half of 2014.

Although it is possible that this will lead to some level of customer attrition, particularly if market rates resume their move lower during the year ahead, it should see the group well positioned to maintain both earnings and dividends over the medium term.

This is appears to be a particularly relevant expectation when considering the rate of customer acquisition which has been achieved by the group throughout the last 24 months (double digits).

However, in relation to the competition and taking into account that Admiral is the industry’s number one in terms of costs and claims (i.e lowest combined ratio), the above implications should also be seen as a particularly relevant consideration for investors approaching the wider industry.

Association of British Insurers Motor Insurance Premium Data

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Balance sheet

In relation to the balance sheet Admiral Group maintained a low level of gearing during 2014, despite the fact that it tapped capital markets for the very first time when it raised £200 million in a bond issue during the summer.

While the capital raising initially prompted some degree of concern among investors as to whether or not the group’s financial position was really as strong as many had anticipated, we believe that the benefits of this move far outweigh the costs.

The official purpose of the move was to help bolster the group balance sheet ahead of the January 2016 implementation of the European Union’s Solvency II capital regime, at a time when interest rates still remained favourable.

This we feel was a wise move given that it mitigates the risk of having to raise capital at a later, potentially less opportune moment.

In addition to this gearing at the group now sits at 35% post capital raising, which is well within the bounds of what can be considered acceptable, while the group continues to boast industry leading returns on capital and returns on equity.

 

The dividend

In terms of the dividend, Admiral continues to pay out almost all of its excess earnings to shareholders by way of interim, final and special dividends. This year the total payout was 1% lower than in 2013, which reflects the impact of a larger 2% decline in EPS for the period, but still provides investors with an attractive yield of 6.4%.

Looking ahead there are good reasons to believe that the dividend at Admiral could come under further pressure in the near term, particularly in 2015 & 2016 (lower margins & lower earnings), although there is also scope for such concerns to prove unfounded.

The longer term outlook for the shareholder payout also remains on a firm footing given the group’s move to raise premium rates in the second half of 2014, in addition to the fact that Admiral’s efforts at international diversification are beginning to pay off; with two of its overseas units now set to post a profitable underwriting result in 2015.

 

The valuation

From a valuation perspective Admiral Group presents analysts with a challenge at present. This is because there are strong arguments for new and continued ownership over the medium to longer term while in the shorter term, the outlook for earnings and cash returns to shareholders remains clouded in uncertainty which makes reliable estimates very difficult.

Both of Admiral’s nearest competitors (Direct Line & Esure) experienced steeper declines in margins, profits and therefore, a sharper contraction in earnings for the 2014 period. This is not surprising in our view, given Admiral’s long held position as an industry leader in terms of operational and underwriting costs.

It is this, combined with the group’s simultaneous position as an industry leader in terms of returns on capital and returns on equity, that informs our belief that an “on par with peers” valuation for Admiral would be to overlook the quality and potential of the group.

Given this view of the underlying business we see a premium valuation as warranted in the case of Admiral Group.

Therefore, with Direct Line and Esure averaging 12X forward consensus estimates for 2015 EPS at present, we derive our floor to the current valuation for Admiral Group.

We then take the non life insurance sector average of 16.45 X consensus and given that the growth outlook for this group of companies as a whole remains brighter than in motor insurance, we also apply this as our ceiling to our valuation expectations for Admiral Group.

With the pros and cons of these two groups of companies in mind, we assume that fair value for Admiral Group rests somewhere between these two points, 12X 2015 EPS and 16.45 X 2015 EPS.

Admiral Group currently trades on a multiple of 15.79X consensus estimates for 2015 which, according to the above methodology, indicates that the group is probably vulnerable to a correction at current levels.

 

The takeaway

A strong performance from the shares throughout Q1 in 2015 means that Admiral Group could now be close to hitting our original price target of 1,620.00 however, the outlook for future earnings at the group remains clouded with uncertainty and our current valuation appraisal suggests that the group is vulnerable to a correction at current levels.

Going forward the number one driver of the shares is likely to be, as always, earnings expectations and changes to consensus estimates for EPS and dividends across the forecast horizon during the coming quarters.

All of the available evidence at present points towards lower earnings in 2015 when compared with those of 2014, including management guidance on margins due to the potential for premium cuts in prior years to translate into lower reserves releases in the current period.

However, there are also reasons to believe that earnings could well surprise on the upside in 2015, not least of all because insurance reserves are an opaque subject, but also because there is now scope for both the Italian and Spanish insurance operations to contribute positively to earnings for the group.

Nevertheless, the outlook remains cloudy as the above evidence to suggest another positive performance in 2015 is weak and flimsy at best.

For this reason we leave our price target for the shares unchanged today at 1,350.00 pence, which implies 11.5% downside from current levels and an earnings multiple of 14 X 2015 consensus, which is at the midpoint between our floor – ceiling range.

The next scheduled event of note for the group is the company AGM on 29 April, which is followed by the release of half year results on 19 August. As always, we shall endeavour to keep all of our members up to date with the developments as they occur as well as at the time of the next release.




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