Hiscox Ltd Interim Update – 18 November 2014
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).
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Earnings are likely to be lower at Hiscox for 2014
Hiscox Ltd issued its Autumn interim management statement in early November where it reported a steady performance in gross written premiums across almost all divisions.
However, management drew attention to pressure upon margins in certain lines as reinsurance and other “big ticket” areas continued to struggle with an excess of available capital during the period (yield seeking financial markets).
In addition to lower margins, the group’s investment performance slipped slightly during the third quarter with the annualised return dropping from 2% in H1 to 1.7% for the year to date.
For these reasons, consensus expectations remain that earnings are likely to be lower for the full year 2014, with the average estimate suggesting EPS of 56.00 pence per share as opposed to the previous 63.00 pence.
Regulator warns on capital
This is while the UK regulator, the PRA, recently sent a letter to senior executives at the UK’s largest insurers warning them against excessive releases of reserves in order to boost earnings ahead of the full year reporting season.
The move comes on the back of what has been a difficult year for many insurers, as lower investment returns and competition driven pressure upon premium rates has squeezed margins across certain segments of the industry.
Although Hiscox Ltd has traditionally held a reputation for being conservative when it comes to reserves releases, it cannot be taken for granted that increased scrutiny upon capital discipline will not impact upon full year numbers.
Despite that it declared, in March 2014, that it held sufficient post-dividend capital to meet the requirements of even the most is not stringent regimes; weather driven claims events in the UK, Europe and Mexico during 2014 could have caused the group to draw down on some of these reserves.
For this reason, it is possible that the group will release a lesser amount at year end when compared with 2013/14 and that this could lead to a lower than expected special dividend for the period.
While the lower earnings performance and regulatory concerns are likely to constrain further share price growth over the near term, therefore impacting upon our second price target issued in April; we remain attracted to the group as a medium and long term play on one of our preferred sectors.
Hiscox Ltd Share Price // Daily Intervals
Hiscox Ltd & general non-life insurance sector update
Despite the difficult macroeconomic backdrop, earnings have proven resilient at the UK’s major insurers.
Some have cited that much of this is due to “earnings lag”, or the delay between when policies are written and when those policies become actual earnings, therefore implying that the difficulties of recent years will be reflected by lower earnings in future periods. However, we disagree with this sentiment.
While we acknowledge that strong financial market performances during 2013 had a substantial positive impact upon earnings for many insurers, and that this is unlikely to be repeated again this year; we see no reason for a significant or sustained backwards movement in earnings for the non-life insurers here in the UK.
Although there are sector specific, as well as case by case, risks to this outlook; we believe the best days for general and specialist insurers are still to come.
In support of this view, we note stable earnings expectations for insurers over the last 18 months, reflected by a lack of upgrades or downgrades to consensus estimates.
This comes in contrast to other sectors across the wider market where, in most cases, upgrades have been frequent as economic growth expectations were revised higher throughout late 2013 and early 2014.
With economic growth, most notably in the euro-zone & the US, underperforming against upwardly revised estimates throughout the year to date; some segments of the analyst and investor community now see it as most likely that earnings expectations across the wider market are overdue a downgrade.
“Given Eurozone GDP was precisely zero in H1 2014, we would question whether in fact we are not due another round of earnings downgrades in a number of sectors during the months leading up to year-end results – absent a very strong economic recovery that is so far proving elusive” – Berenberg Bank, September 2014
This implies that a certain degree of outperformance from the sector is still likely, relative to the market, which supports our long held view that certain segments of the insurance industry continue to offer good value. This is particularly the case when considering the evolving monetary policy environment in the UK and the US, which we still expect to boost earnings over the medium to longer term.
The sector currently trades on a multiple of 11.44X projected 2014 earnings, which compares well with the FTSE average of 15.4X, the life insurance average of 16.4X, the financial sector average of 18X and the banking sector average of 25.1X.
We see this valuation as providing a firm cushion against any notable downside for the large cap non-life general insurance sector.
The below graphic illustrates the share price performance of Hiscox Ltd relative to its nearest competitors over the last four years, with specialist insurers Hiscox Ltd and Beazley Group Ltd holding a clear lead over the rest of the class.
Hiscox Ltd (Blue), Beazley Plc (Black), FTSE 100 (Purple), AXA SA (Red), Catlin Group Ltd (Orange), RSA Insurance Group Plc (Green)
Hiscox remains attractive as a medium to longer term play on evolving monetary policy and economic recovery.
While there are wide expectations that earnings for the group will be lower this year, following a strong investment performance in 2013 and increasing pressures on rates in CAT risk & reinsurance, the general consensus for subsequent years is that earnings will stabilise at 2014 levels and are in little danger of a downgrade from there.
On a price to earnings basis, the valuation for the group is reasonable at a slight premium to its peer group while we believe that there is credible evidence to suggest that the sector is undervalued relative to the wider market. In short, we remain highly attracted to insurance as a theme and shall continue to seek opportunity in this space going forward.
While we continue to hold a positive outlook for the shares, after meeting our initial price target at 720.00 pence during the middle of Q3, they have pulled back quite sharply. Since this time, firm support has been established at the 620.00 pence level.
Given the depth of the pullback and the fact that earnings are likely to be lower for the full year, we see little scope for HSX to close the gap between the current market price of 680.00 pence and our second price target of 820.00 pence within a reasonable time frame.
For this reason, we revise lower our expectations for the shares over the coming quarters. In the absence of a sector wide rerating higher, we anticipate that the shares will now average there current price for the foreseeable future.
While our revised expectations are likely to prove a disappointment for those hoping to see further gains from the group in the short term, we note that we maintain our positive guidance for Hiscox Ltd, as well as a number of its close competitors over the short, medium and longer term.
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