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Hiscox Ltd Half-Year Update – 22 August 2014

 

Earnings fall at Hiscox on Foreign Exchange Losses; Mixed Interim Update Prompts Shares to Drop

Following a strong 2013 year of growth, investors in Hiscox Ltd were dismayed this month when the group unveiled a deceleration in earnings for the first half of 2014.

The earnings pressure came mostly as a result of a lesser performance of the group’s investment portfolio, adverse foreign exchange movements and competitive pressures upon rates in the reinsurance & catastrophe risk insurance businesses. 

The strength of sterling relative to other major currencies also proved to be a headwind for the group, as rate movements ate into US dollar and euro income. This is while the excessive “reaching for yield” from large institutional investors has driven higher inflows of capital into the CAT bond and reinsurance markets, leading to lower rates of return on underwritten risks.  

In detail, the group reported a 3.8% decline in gross premiums written while its combined ratio slipped from 74.7% during H1 2013, to 82% during the first half of the current year.

In relation to earnings, Hiscox reported a 30% slide in pre-tax profits and a 14% reduction in earnings per share for the period.

The poorer financial performance led management to sound a cautionary note on the environment for premium rates in reinsurance and catastrophe risk going forward, by saying that they may shrink these operations for the time that rates remain on a downward trajectory.

Consequently, some investors have taken flight and the shares have now fallen back to 646.00 pence, close to their 2014 starting position.

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Going Forward

As referenced previously, our core attraction to Hiscox Ltd is the way in which the group is positioned to benefit from rising interest rates in the UK and the US.

It is encouraging to note that investment income at Hiscox increased during the first half of 2014 from 1.5% to 2% on an annualised basis. Although growth in portfolio returns remains meagre at present, there are now broad expectations among investors that both the Bank of England and the Federal Reserve will begin hiking rates during H1 2015.

This bodes well for earnings at Hiscox during subsequent periods and could mean that higher investment returns are set to become a more prominent driver of financial performance earlier than we had initially anticipated.

In addition to this, higher investment grade yields would be positive for the scaled back businesses such as reinsurance and catastrophe risk as they could be expected to soak up at least some of the excess capital, which has found its way into CAT bonds and the reinsurance underwriting market.   

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Summary

In summary, we continue to believe that Hiscox Ltd has a bright future ahead of it, despite a tough trading environment for reinsurance and catastrophe risk operations.

With the UK and US economies now entering into an environment where investors are actively positioning for a period of higher rates, we believe there is a strong case for expectations that both earnings at Hiscox, and interest in the group’s shares, will increase over the months and quarters ahead.

Consequently, we remain attracted to the stock. Since our initial price target of 720.00 pence per share was reached during the opening stages of the year we have been targeting higher levels. Today we maintain our April price target of 820.00 pence for the shares.

On a less positive note, we caution that while strong support exists at the 625.00 pence level, the shares would be vulnerable to a downward leg toward 590.00 pence in the event of a sudden natural disaster (of global significance) or if premium rates in reinsurance and catastrophe risk were to continue to fall during the months ahead.

Hiscox Ltd Share Price at Hourly Intervals

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Hiscox Ltd Share Price at Weekly Intervals

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