A fairly negative broker note, from MS, highlighting climate-related risks to the insurance underwriters, is weighing far more heavily on SUN and IAG than I would have imagined.
Some general thoughts. As always, you take some modest risk penning thoughts like this, because it is possible the analyst in question has a stronger handle on current trading than we, or the broader market, did or does and that the companies in question are just about to disappoint the market via a downgrade, citing the very reasons flagged.
Anyway, let’s take a long-run focus on what kind of earnings trajectory is required for SUN to generate a “market-like” rate of return.
Recall here that we extrapolate the market capitalisation out a decade, from current levels, at a CAGR of 7%, and de-capitalise that 10yr forward implied market cap at a range of different multiples to calculate a 10yr forward implied NPAT.
We (in logs, to account for exponentiation, and to make it easy to visually compare) compare the resultant earnings trajectory, necessary to produce those outcomes (see the red lines, that connect to an earnings base).
On that basis, SUN doesn’t need to grow beyond near term consensus estimates, and hence upside exists given leverage to higher bond yields.
Of course, maybe catastrophe claims, natural perils, and losses generally mount, given those climate risks, and the actual earnings outcomes are not flat at all, but rather decline, and decline more precipitously than anticipated. That’s certainly possible. There’s no magic law that forces the claims/loss rates to look like the below forever.
But you’d have to wonder why GWPs wouldn’t reprice, given the duopoly, in that case, if the underwriting is perpetually, cumulatively riskier, ex-post, relative to ex-ante expectations.
And it would seem to me that they are indeed able to grow premiums over time, as per the above graph, and the below pricing metrics.
In any case, it would seem that multiples have de-rated, to reflect the greater volatility in earnings, but, we should note that the broker piece does of course note flag that multiples haven’t de-rated enough, so perhaps my point in the comparison is moot.
Still, we shall take a risk, and remain happy holders with the insurance companies more generally (QBE, MPL, SUN) and note that perhaps the downgrade risk is higher, for the coming August result, than we understand them to be.
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