Hiscox Ltd Full Year Update – 01 April 2015
Hiscox Ltd is a specialist insurer with a core focus on catastrophe risk as well as additional lines such as marine and aviation, political risk, fine art, terrorism and HNWI kidnap & ransom. In addition to the above, Hiscox also underwrites more niche big ticket items such as interplanetary probes and observation satellites.
The group also has a significant footprint in reinsurance as well as a strong presence in the London market through its own syndicate at Lloyds of London (Syndicate 33).
|Index||FTSE 250||Ticker||HSX.L||Latest Close||872.50|
|52 Week High||893.72||52 Week Low||648.59||P/E (H)||12.9|
|Dividend Yield %||2.58||Dividend Cover||2.9||CEO:||Bronek Masojada|
|CFO:||Stuart Bridges||Previous Price Target||820.00||New Price Target||820.00|
A strong performance from Hiscox shares during Q1, aided by a reasonable full year update
At the time of our last update on Hiscox Ltd there were increasing concerns among the analyst community, as well as management, over an excess of capital in the reinsurance space. This led to heightened expectations that earnings would probably suffer as a result of the consequent pressure on margins.
Given these concerns, we adjusted our guidance in our last report to accommodate what was likely to be an increased length of time before the shares were able to reach our price target of 820.00 pence.
During the intervening period our adjusted guidance has proved unnecessary as a mild winter across much of Europe and what was still a positive tone from management in relation to capital returns led investors to rethink their expectations for full year earnings at the group.
Consequently, Hiscox shares tracked much of the non life sector higher throughout Q1, before reaching our price target of 820.00 pence in late March as investors piled into the shares ahead of the dividend record date.
Hiscox Ltd Share Price / 8 Hour Intervals
Hiscox thinking outside the box to boost shareholder returns in a challenging environment
While the environment for reinsurance and investment returns remains tough, the overall business at Hiscox has continued to perform strongly during 2014. This was evidenced by strong premium growth across most over divisions as well as record profits in the UK and European segments of the business for 2014.
Although profits at the group level were lower for the year, Hiscox managed to partly offset the impact of this upon earnings through a share consolidation that saw 8 new shares issued to investors in exchange for every 11 existing shares in the group.
This helped to boost total dividends and special distributions to shareholders by 18%, with total returns rising from 57 pence per share, to 67.5 pence. Although it is worthy of note that the group post tax return on equity was marginally lower for the period at 17.1%, but still attractive at this level.
In a further positive move for the quarters and years ahead, Hiscox continued to reduce its presence within unprofitable areas during 2014, evidenced by a planned 13.9% reduction of premiums written within reinsurance.
Looking ahead the group expects the majority of growth to come in the US and European businesses although it does expect that the wave of consolidation within the Lloyds market to be positive for both competition and recruitment.
In terms of challenges the group expects that the investment environment will remain tough while in large ticket areas, an excess of available capital is also likely to continue to pressure margins and risk adjusted returns.
For this reason the group will probably make further reductions in its exposure to large big ticket risks during the period ahead, although the same factors that have created this pressure are also expected to drive a positive result for Hiscox’s newly created investment management operation Kiskadee ILS.
This is a new investment management arm of the group that originates insurance linked securities to underwrite large risks, which should see Hiscox able to earn revenues off of the excess capital in the industry without exposing itself to the risks that come with underwriting big tickets on low margins.
Investment return was marginally lower for 2014 as Hiscox positions itself for higher rates
We have written at great length previously describing how rising interest rates are a key part of the Hiscox investment case.
This is because investment returns once accounted for a considerable portion of post tax profits for the group, while in recent years the contribution to earnings from investment income has fallen off from the edge of a cliff as interest rates across the developed world have remained at record lows.
In 2014 there was no positive movement in this regard for the group as investment returns for the period came in at 1.8%, a fraction lower than the 1.9% achieved in 2013.
Despite this, we are pleased to see that Hiscox has began to concentrate its cash available for investment on short term sovereign bonds with a duration that enables the group to hold the securities until maturity.
While the primary purpose of this move is to avoid losses when rates begin to rise, we are encouraged by the development as we expect that short term notes will be among the first to boast higher coupon rates when the Federal Reserve and the Bank of England do eventually begin to raise base rates.
This will be positive for the investment performance and for post tax earnings at Hiscox over the medium term.
Balance sheet, dividend and valuation
In terms of the balance sheet, Hiscox continues to maintain a strong capital position, even in the face of the looming implementation date for the European Union’s Solvency II regime.
This has been evidenced by the group’s ability to continue to increase cash returns to shareholders during what has been a difficult trading period for many insurers, in addition to its ability to maintain a low level of gearing.
In relation to the dividend, total shareholder returns were 18% higher for the 2014 period, with the value of payments rising from 57 pence per share, to 67.5 pence. This figure includes the payment of special dividends for the period which, when combined, saw Hiscox provide a dividend yield of 7.7%.
The group also carried out a share consolidation at the opening of 2015 which saw 8 new shares issued in replacement of every 11 existing shares. This should help to boost the group’s performance in terms of earnings per share and dividends per share in the event of another drop in earnings for 2015.
However, it is worthy of note that management warned on the future outlook for special distributions in this year’s annual report. This was as the board stated that the higher payout for the year was largely the result of a lack of profitable underwriting opportunities in some areas, which would not always be a problem for the group.
For this reason it appears possible that when rates improve across some of the bigger tick, more competitive areas, then management could choose to return less capital to shareholders by reducing or scrapping the special distributions.
From a valuation perspective, Hiscox is close to being fairly valued after having traded as high as 894.00 pence in March this year. This is as at these levels the group trades on a forward earnings multiple of 15.5X consensus estimates for EPS in 2015, which is only a fraction behind the wider industry average of 16.5X.
For this reason we believe that, from a valuation perspective, any further noteworthy gains may prove difficult to sustain over the near term. Also in relation to the short term, the shares are beginning to appear vulnerable to a correction given the pace of acceleration between Q4 2014 and Q2 2015.
On balance, Hiscox’s full year results update was better than many had projected, with the group managing to increase both earnings per share as well as total cash returns to shareholders despite what has been a difficult trading period for all in the industry.
In addition to this Hiscox has positioned itself well in order to take advantage of higher coupons when benchmark rates begin to rise in the UK and the US, while minimising the disruption that this may cause to its existing portfolios.
It is also encouraging that the group has further reduced its exposure to risk in reinsurance and other big ticket lines, while at the same time attempting to turn the excess of available capital within these areas to its advantage (Kiskadee ILS).
However, despite the numerous positives in advocating for the group, the outlook for earnings over the near term is far from certain. In this regard we note that the current consensus for EPS implies 19% downside to earnings per share in 2015.
While it is possible that the share consolidation that took place in March this year may be able to offset some of this downside pressure upon earnings, earnings are still likely to fall to some degree over the next 12 months.
This is while it is also possible that the group will decide to reduce the level of special distributions to shareholders, in order to write more business, if margins were to show improvement in some of the more competitive areas over the next 12 months.
Each of the above factors represents a hurdle for Hiscox Ltd shares over the near term and it is with these in mind that we hold our price target today at 820.00 pence.
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