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Wildfires in Europe and Hawaii further raise the temperature of the debate over global warming and climate change and – from the narrow perspective of investment – non-life insurers are coming off badly as a result, owing to the perceived increase in risk associated with their business model.
Shares in Lancashire, the Lloyd’s of London syndicate manager, are paddling sideways as a result, but it can be argued that the industry’s fundamentals are much stronger than they seem and that the stock is undervalued as a result.
Higher claims thanks to natural disasters, higher repair costs thanks to inflation and higher costs of capital are all undeniable headwinds.
But this combination is taking capacity out of the insurance market at a time when demand is increasing.
As a result, for those players strong enough and smart enough to withstand the storm, headline insurance rates are rising, and non-life insurers can show rapid premium growth as a result.
According to this month’s first-half results, Lancashire showed year-on-year growth in gross premiums written of 26pc to $1.2bn, a figure that exceeds that for the whole of 2021 and represents three times the equivalent sum in the first six months of 2018, a mere five years ago.
The FTSE 250 company’s earnings power may also get a lift from rising interest rates and rising bond yields, another intriguing differentiator that helps underpin the investment case laid out here in May 2021.
Lancashire has a $2.5bn investment portfolio that is parked primarily in “sovereign” (government) bonds.
An increase in yields here to 5pc or more neatly adds $125m to pre-tax income, a figure best seen in the context of how Lancashire’s highest annual pre-tax profit since its 2005 London listing is the $392m achieved in 2007, according to data from Refinitiv.
The first half’s net investment return of 2.2pc, or $63m, backs up the maths.
Higher premiums plus higher investment income should prove a powerful combination, even assuming the “combined ratio” (a proxy for the margin that an insurer can make on the business it writes) proves higher, and thus the margin lower, than the long-run average seen since 2005.
That in turn could fund healthy dividend payments. Lancashire has not declared a special dividend since 2018 and the first-half results offered an unchanged payment of $0.05 (to be paid on Sept 15), while the forecast yield of just north of 2pc may not have caught everyone’s eye.
But the company has paid out or announced dividends worth more than 835p a share since its flotation. That is a significant sum when set against the current share price of 569.5p and one that counsels patience.
Lancashire was incorporated 18 years ago when it seemed that the catastrophe insurance market was on its knees in the wake of Hurricanes Katrina, Rita and Wilma, and its decision to raise $1bn in capital and start to underwrite business paid off handsomely.
Lancashire offers a tempting combination of higher earnings power and a lowly valuation.
Questor says: hold
Ticker: LRE
Share price at close: 569.5p
Update: AG Barr
Rather like Lancashire, the soft drinks maker AG Barr has done everything this column hoped of it since our first look in August 2019, despite a difficult operating backdrop.
Unfortunately, the share price has failed to respond, although our near-20pc book loss on the stock is partly mitigated by 39.1p a share in dividends, while a trading update at the start of the month suggested that the Scottish company remained on the right track as it prepares for the retirement of its chief executive, Roger White.
The business, famous for Irn Bru, Rubicon and Tizer, now has a wider portfolio of products beyond fizzy treats thanks to the purchase of energy and protein drinks specialist Boost and oat milk maker Moma.
Those brands and their loyal customers confer pricing power – a useful ally in inflationary times – and that in turn supports high returns on capital, cash flow and ultimately those dividends.
Near-term trading momentum also seems strong, judging by the 10pc organic sales growth in the first half, a figure supplemented by the purchase of Boost last Christmas.
A delay in Scotland’s controversial deposit return scheme also feels like an incremental near-term bonus and White and his team now see 2023 earnings exceeding analysts’ forecasts, despite investment in the brand portfolio and the integration of Boost.
A share price of around 15 times forecast earnings, with a dividend yield of some 3pc, based on consensus analysts’ forecasts, looks perfectly acceptable for a company with a history of double-digit operating margins and returns on capital and a balance sheet that carries no debt.
We’ll stick with AG Barr.
Questor says: hold
Ticker: BAG
Share price at close: 486p
Russ Mould is investment director at AJ Bell, the stockbroker
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