Friday, June 15, 2012 / ARM Research
 

Strong premium growth

Continental Reinsurance recently released Q1 2012 financial performance, reporting a 25% YoY growth in gross premiums (non-life) to N2.6 billion and 15% above our estimate. Much of this growth came on the back of a 59% contribution from its fire and accident business; its two strongest business lines traditionally.

Expenses on the rise, but underwriting profit remains strong

Reinsurance costs rose 35% to N267 million, continuing a trend of increased reinsurance costs witnessed amongst insurers in the last two quarters. We believe this is due largely to the increased claims incurred by most insurers in 2011 following flooding in various parts of the country and increased risk aversion across the industry.

With regard to the latter, the company’s retention rate declined 200bps YoY to 88% on the back of higher reinsurance costs.  Also, claims incurred rose 13% YoY to N1.03 billion, raising claims ratio to 39.45%, which reflects industry wide trend from more aggressive claims pursuit by policy holders’ reportedly linked, in part, to falling discretionary income.

Furthermore, the company’s acquisition cost grew 38% YoY to N535 million, which bumps acquisition costs as a percentage of gross premiums 187bps higher YoY and reflecting, in our view,  increasing competition in the industry which has heightened willingness to pay more to acquire business a bid to grow premiums. Adding to the company’s growing expense profile was a 29% YoY rise in management expenses to N268 million.

Despite an acceleration in costs, underwriting profit rose 30% YoY to N407 million in Q1 2012, indicating underlying strength in company’s core business.  Underwriting profit margin rose 53bps to 15.55% during the period sustaining a recovery since a Q2 2011 slump that was driven by sharply higher claims and acquisition costs.

Investment income supportive of profits

Investment and other income grew 16% YoY to N230 million, a feature that has cut across our coverage within the industry thus far in Q1 2012 results. As with other insurers, Continental Re has clearly benefited from of the recent rise in fixed income yields, a phenomenon buttressed by an 80% increase in Treasury bill in the company’s investments portfolio from FY 2011.

On the back of a sturdy performance in its core business and stronger investment income,  PBT rose 35% to N567 million, 25% above our N455 million estimate and puts pre-tax margin at 22% for Q1 2012 from 21.4% in Q1 2011, (GTA: 9% in Q1 2012). Furthermore, current pre-tax margin signifies a 5ppts improvement from FY 2011, continuing an improving trend from Q3 2011. PAT also rose 35% to N453 million, 25% ahead of our N364 million estimate. This translates to a 121bps YoY improvement in net margin to 17.32%, well ahead of the 7% recorded for peer GTA, but still short of 22% figure for Custodian in Q1 2012. We believe much of the improvement in profitability is as a result of steady performance in its underwriting business from Q3 2011 after a significant dip in Q2 2011.

Cautious optimism as growth tempers concerns

We were concerned about the company’s ability to grow premiums in 2012 following a decline in premiums for FY 2011, more so as peers AIICO, GTA and NEM averaged 29% growth during the period. Q1 2012 performance however gives reasons for optimism, following stronger than expected growth. We believe the company’s fire and accident business lines (its strongest traditionally) will remain strong and continue to support premium growth as recent commencement of enforcement of compulsory classes of insurance begins to bear fruit. In addition, reinsurance rates have grown substantially across our coverage in the industry suggesting increased risk aversion across the industry and increased reinsurance business for Continental Re.

Despite 25% growth in premiums in Q1 2012, we await a sustained trend in strong premium growth in the coming quarters to ease concerns about premium growth after a mixed performance across quarters in 2011. As such, our forecast 18% YoY growth in premiums for FY 2012 to N11.38 billion is slower than 3 year average of 39%.

We believe steady performance in its core business over the last 3 quarters supports our expectations for relatively steady margins going forward. In addition, with yields in the fixed income environment remaining quite attractive and the company’s conscious effort to take advantage of this as witnessed by a reshuffling of its balance sheet, we believe investment income will remain supportive of profitability. We however believe rising acquisition costs will likely weigh on profits. The adjustments we made to reflect these considerations result in a forecast a PAT of N1.2 billion for FY 2012.

Valuation
Our current PAT forecast of N1.2 billion for FY 2012 implies an estimated EPS of N0.12. Our forecasts yield a target price of N0.89 for the stock. The stock currently trades at a 2012 forward P/E of 6.1x and P/B of 0.58x, compared to an average of 4.7x and 0.5x respectively for stocks under our coverage. Nevertheless, yesterday’s closing price of N0.71 implies a 25% discount to our current target price and thus we retain our BUY recommendation.

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