Share tip of the week: non-life insurer for income and growth
By
Paul Hill Aug 21, 2009
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Non-life insurance companies are in the risk business, offering everything from property insurance to medical malpractice insurance. It's a complex sector, but worth making the effort to understand as it holds some attractive opportunities, such as Bermuda-based Catlin, the biggest underwriter on the Lloyd's of London insurance market.
To value a stock in this sector, you have to determine which operators make money by looking at the 'combined ratio'. This measures underlying profitability by comparing claims and costs to premiums. A ratio above 100% equates to a loss.
On this score, Catlin achieved 96% in the first half of 2009, after being hit by one-off events such as February's Australian bush fires and the Air France disaster in June. This ratio is set to improve to around 92% in the second half, driven by higher premiums and further cost savings. That's better than many of Catlin's contemporaries.
Next, in light of the recession, we need to keep an eye on investment portfolios. Insurers are experts in risk assessment, rather than fund management, and so it's crucial to scrutinise their asset quality. Here Catlin adopts an almost neurotically cautious approach (which I like), aiming to avoid the worst of any future equity crisis. As of 30 June, the firm had $6.7bn of assets under management, of which 42% was in cash, 48% in bonds and just 10% in shares and hedge funds.
Catlin (LSE: CGL), rated a BUY by Numis Securities
Finally, there are the three most important metrics, where Catlin ranks highly against its peers. The City is expecting 2009 earnings per share (EPS), dividend and net tangible asset value (NTAV) to come in at 62.1p, 24.6p and 315p respectively, rising to 73.1p, 26.9p and 350p in 2010.
Assuming these targets are met, Catlin trades on 2010 p/e, yield and net asset value (NAV) multiples of 4.3, 8.5% and 0.9. That looks good value for income seekers and growth investors. But this rating doesn't value its growing franchise, which has historically generated mid-teen returns. Catlin also raised $289m in March via a rights issue at 205p, which should help underpin the dividend.
What are the possible pitfalls? Results in this industry can be blown apart (as in 2008) by unexpected natural disasters, such as Hurricanes Ike and Gustav, or from the impact of the financial crisis on investment returns. The firm is also exposed to foreign-exchange fluctuations, as well as claims from clients who are being hit by class-action lawsuits alleging director negligence.
There's also the risk that premiums could soften, although following AIG's troubles, underwriting capacity has actually shrunk and the competitive landscape has improved. With a desirable brand and hardening premiums, I'd rate Catlin on a 1.2 times 2009 NAV multiple, or 378p a share.
Recommendation: BUY at 313p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
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