FBD Holdings – Buying the premium turn
Notwithstanding the cyclical nature of the insurance industry, FBD has a highly capital accretive business model driven by its structurally low cost base and high earnings capacity. On a risk adjusted basis, we believe FBD is one of the best equity plays on the recovering Irish economic story. With an internal RoE target of 18% for its insurance business (c. 95% of assets) and determination to pay a high level of future dividends, the current share price presents an attractive investor entry point in our view.
We initiate on the FBD stock with a BUY recommendation and a price target of €22.2 (equates to c. 20% upside from current share price)
Turn in premium cycle anticipated: We see recent competitor difficulties and severe weather events as catalysts for rates hardening in the Irish non-life market, with the sector re-pricing risk and improving underwriting discipline. Anecdotal evidence suggests that policy holders have faced increased premium pricing in the first weeks of January as they seek to renew policies. Furthermore, the appetite for insurable risk and cover is set to rise in line with the recovery in Irish domestic demand.
Farming base source of competitive advantage: FBD benefits from historically close relationships to the Irish farming community (c. 80% market share), with its strong sector linkages effectively creating a barrier to entry. The group has maintained and developed this lucrative, low cost recurring income stream (farming customers and related connections equate to c. 42% of FBD’s total premiums). Encouragingly, farm incomes are forecast to grow this year with the sector to receive a further boost in 2015 when the European Commission quota system is abolished. This should trigger expansion in the industry as farmers move to increase dairy production.
Move away from short term low risk investment allocation: Reflecting a prudent investment strategy, FBD has focused on reducing risk and volatility in recent periods. However we expect the group to begin to take a less conservative investment approach in 2014 as it seeks to reinvest in medium term government and corporate bonds, while also increasing its equity exposure.
Significant scope for payment of special dividends: Facilitated by further market share gains, we expect FBD’s Gross Written Premium to increase by 3% annually from 2014 to 2016. However due to FBD’s strong internal capital generation we forecast surplus distributable reserves of €140m in 2016 (equates to over €4.20 per share / 22% of market cap). While some of the capital surplus is likely to be utilised for new business purposes, we expect the group to reactive special dividend payments over coming years once final clarity emerges on final Solvency II regulations.
Merrion Stockbrokers Limited (registration no. 307878)
is a limited liability company whose registered office is at
Block C, The Sweepstakes Centre, Ballsbridge, Dublin 4, Ireland.