Who thought insurance would emerge as one of the most exciting ASX sectors this financial year? A few outstanding small insurance floats, some undervalued established players and the upcoming multi-billion-dollar privatisation of Medibank Private have sparked interest.
I will reserve judgement on Medibank until the prospectus is released and there is a sense of valuation. Still, government privatisations have a habit of rewarding investors, and a successful float of Medibank could lure more retail investors to the IPO market and the insurance sector.
The new players
For now, I favour small and mid-cap players. Insurance broker Steadfast Group was among the higher-quality floats of 2013 after raising $333 million and listing in August. Its $1.15 issued shares have climbed to $1.59 and it delivered a slightly better-than-expected half-year result.
The well-run Steadfast looks a steady long-term performer that can grow organically and by acquisition in a fragmented insurance-broker market. But its price has run too hard for now and some consolidation is in order.
The same could be said of travel insurance provider Cover-More Group. It listed in December after seeking $521 million in an IPO, and trades at $2.11, compared with a $2 issue price. Like Steadfast, it is performing slightly ahead of prospectus forecasts, judging by its February trading update, and looks marginally overvalued. Both stocks would be better bought on a 5-10% correction.
iSelect
iSelect is a more interesting proposition after heavy price falls. It raised $215 million in a prominent IPO, listed in June 2013, and sunk from a $1.85 issue price to as low as $1.05 as the Australian Securities & Investments Commission queried aspects of its prospectus. It is now $1.06.
I am warming to iSelect at current prices – admittedly, a contrarian view. The stock is deeply out of favour, most brokers have hold or sell recommendations, and the market is rightly sceptical after it downgraded revenue forecasts within months of listing – a cardinal sin for any IPO.
iSelect has a new CEO and plenty of work ahead to restore market confidence. Hefty premium increases on health insurance will work in its favour, as investors increasingly use comparison sites to compare policies and find cheaper ones.
We know from the history of Seek, REA Group, Carsales.com and others that one internet site tends to dominate its sector over time, and enjoy strong barriers to entry through the network effect of higher traffic, leading to more advertising and higher traffic again.
For all its post-listing problems, iSelect has a good market position and a well-known brand. But I suspect the share price is going to get worse before it gets better, making iSelect best bought at lower prices.
Austbrokers Holdings
As insurance IPOs – past and upcoming – hog media headlines, the best current investments are in established players such as Austbrokers Holdings (AUB).
Austbrokers had been a small-cap darling: a five-year average annualised total shareholder return (capital growth and dividends) of 28% is exceptional in this sector. Fund managers loved its growth potential in the huge, though incredibly fragmented, SME insurance market.
Austbrokers slumped from a 52-week high of $13 to $10.34. It disappointed the market in March after maintaining earnings guidance for FY14 at a 5-10% increase in adjusted net profit. Uncertainty in the SME sector and heightened industry competition led to flat premium growth.
I could not find enough in the profit report to warrant such a sharp share-price fall. More likely is Austbrokers was dumped in a bout of profit-taking after rallying in the first half of 2013. Perhaps some fund managers took profits and rotated into Austbrokers’ nearest listed peer, Steadfast.
Austbrokers has excellent long-term prospects. Small and medium-size enterprises often complain about rising premiums, but cannot operate without insurance. Moreover, the huge SME insurance market is still incredibly fragmented: Austbrokers can continue to grow for years through small bolt-on acquisitions.
Firms that grow through a seemingly never-ending stream of acquisitions are not to everybody’s taste. All too often, the acquisitions supercharge earnings-per-share growth before the wheels fall off and the company is left with too much debt and a declining return on equity.
However, Austbrokers has a strong acquisitions record. Allowing principals of acquired firms to retain equity, keeps them highly motivated and aligns interests. Overall, it is hard to conclude the strength of Austbrokers’ business model or industry position has diminished, despite price falls.
Moreover, a big headwind – SME uncertainty, which reduces demand for insurance – could ease, or even become a modest tailwind for Austbrokers if the Australian economy continues to improve. Rising business confidence and surveys showing higher pricing expectations are good signs.
Either way, Austbrokers looks the best value of the small insurance stocks. Short term, it could fall further, given current negative sentiment. Having more than quadrupled in four years, it was due for a decent pullback.
Long term, this is a strong small-cap company. Austbrokers might not be a screaming bargain yet, but it offers enough to attract long-term value investors at current prices.
Tony Featherstone is a former managing editor of BRW and Shares magazines.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
