Tuesday, 6 March 2012

Admiral Insurance: 2011 full year results tomorrow

Admiral @ 1017p, -27p (-2.59%).

I have been very tempted in the past to invest in Admiral.
Again after their last couple of disappointing quarterly trading statements, and more recently following Credit Suisse's upgrade to outperform (http://www.sharecast.com: Broker snap: Credit Suisse upgrades Admiral to outperform) ahead of tomorrow's final results.
But, with the share price having appreciated already from their recent lows it looks too much of a gamble given the 50/50 chance of the results being well received or not.
Historically the company seems well run and the 2 founder/directors retain large stakes in the company so seem well motivated by the healthy dividend.
It has good cashflow which at 79.04p per share exceeds earnings per share (as you would expect from an upfront premium business) but has seen its premium prospect rating tarnished somewhat by a proposed investigation of referral fees and, in the last 2 quarterly statements, a worsening trend in personal injury claims which is hugely ironic given that we all seem to be paying for that trend.
So although the company has continued to increase cash balances (2010: £246.70m) there is this perceived threat to future profitability as margins on premiums are eroded.
This seems to be what the company refers to as reserve releases which have been reducing as its loss ratio increases.
My interpretation (rightly or wrongly) would be that an estimated margin on premiums received is placed in reserve (against claims) and then adjusted prior to a proportion being released into profits. The adjustment being for the loss ratio on claims which is the actual cost to the company of accident losses.

"...the reported loss ratio for H1 2011 was
76% v 66% in H1 2010. The UK market loss ratio for the 2010 accident year (the most recent
data available) was 92%. Our loss ratios remain significantly lower than the market."

So the loss ratio could still be below the markets 92% (I assume that's an average) but having increased by 10% already might well worsen further and closer to the average.

Picking the following from the interim statement;

... However, consistent with the trend reported in H1 2011, the frequency and expected cost of new large personal injury claims has remained above historical levels of experience. This leads us currently to expect some adverse development at the full year on the projected ultimate loss ratios for 2010 and 2011 which would affect both overall reserve movements and recognised profit commission.
If there is no reversal in Q4 of this higher than normal level of large claims, we anticipate that full year pre-tax profits will be towards the lower end of the range of analysts’ estimates, or some 10% ahead of 2010, with no further reserve releases in the second half."

So although 10% would still represent record results and be in the range of suggested expectations by the company I think it more important for the company to demonstrate that the trend in personal injury claims once again falls back to historical levels.
Anything else would obviously be a concern on a number of levels as the company would then need to find a means of increasing premiums to restore its profitability. 
This might be difficult in the short term, makes the company less competitive with its rivals and suggests a worsening trend to us all as motor insurance customers.

Can't find enough clues (other than the Credit Suisse comments) to suggest that the company might be ready to report that this trend has been brought under control.

"The key focus of the result will be on bodily injury, where the content and tone of management commentary may cause volatility (in both directions)," analysts said (Sharecast).

I read that as hedging their bets then.
If it doesn't report positively then the shares could well fall back again until the industry's collective premiums catch up with increasing liabilities.
It could well be that after having been trading for x number of years and achieved the level of growth in client numbers that it has. It now has an underlying level of risk expense from its targeted demographic that it hadn't fully envisaged and must now absorb.

So despite the prospect of a chunky dividend, I find myself still not ready to invest in Admiral until the picture becomes clearer.
I might miss the boat again but don't feel I am lucky enough to take on the 50/50 chance of a painful short term hit.

Related links:
- http://www.admiralgroup.co.uk/pdf/annualreports/2011_interim_statement_nov.pdf


  1. Hi MA,

    I think I class you as a income investor. Your portfolio are mostly big brand, prominent players in their field, excellently run business and importantly all delivering dividends.

    Reviewing your portfolio, you don't seem to hold Bonds. what's your take on this investment instrument? Also, I was wondering if you could give me you perspective on Aviva...I think it's a stable company, high chance of greater dividends in future. But when I look at price of its bond offering (83.75) @ a coupon of 6.125%, maturing in 15 years.......why in your opinion is it such a low bond price? Your thoughts appreciated...

  2. Hi Ritsut,


    It has crept up on me a bit but probably has more to do with my adapting to the environment and evolving (I hope) with experience (both good and bad), through various investment philosophies: speculative, momentum, growth, value etc.
    Would my portfolio look like this if the credit crunch hadn't happened, who knows?
    But I liken the last few years to the imbalance created at the time of the tech bubble (for very different reasons, of course) which led to good businesses becoming out of favour and oversold with resulting high yields.

    The key attractions being the high yields (and recovery re-rating) from established, well known, and very profitable "bricks and mortar" businesses.

    Could we be in a "twice" in a lifetime situation?

    So, it is this imbalance of value and shareholder returns that I am focussed on whilst revisiting my understanding of the benefits of re-investing dividends and compounding returns from longer term ownership.

    It does mean that I have allowed to pass me by a number of smaller companies with "potential" but you can't invest in every situation.

    I also have my millionaire plan in mind (post:- How to make a Million (by the time you are 65)!), so am trying to focus on the absolute return of which growing dividends can play a significant part.

    Once they have given it to you they can't take it back (unlike surges in share price) but it enables you to grow your portfolio in ways that the main indices can't.

    The very act of giving a dividend is itself diversification as it is a split of capital from the original investment.

    There is an element of self preservation and personal risk management in this as well though, and it will be a test of my discipline during a bull market as investors' attitudes to risk tends to heighten as markets fall but loosen when markets rise.

    I do look at bonds for diversification but find that I am usually behind the curve ie their normal behaviour is to run inversely to equities on which I am more focussed so, by the time I look at them...

    I have also tended to be more interested in Govt issues but believe that QE etc have created an artificial market in Govt bond prices (strange that Gordon Brown created a similar bubble in the early 2000's). By the same token generic Euro concerns could be depressing corporate bonds thereby increasing yields.

    As a result my non-equity investment (the balance is traditionally about 50-50), tends to be in Cash ISA's and NS&I Index linked savings certificates (RPI+) (post:- The Return of the NS&I Index Linked Saving Certificates ).

    This is obviously lower risk but has less potential as well.

    Aviva does have associated risks though, particularly in relation to its hedging strategy in its trading regions e.g. Italy where it holds bonds against its life insurance contracts.

    There are also concerns about its capital position but these most recent results have eased that a little whilst allowing the company to increase its dividend.

    83.75 with a 6.125% yield does look attractive though as you benefit from a fixed yield, potentially some capital gain, and a partial hedge against equities (although if Aviva shares bomb then the investment underlying the Aviva IOU becomes a liability).

    Anything above a 5 year remaining term qualifies the bond for holding in an ISA which then exempts you from income tax on the yield (which is usually paid gross), as well as CGT should you sell at a profit (although your annual capital gains allowance might be enough to exempt you from this).

    Remember though that the yield here will be fixed against your entry price whereas the yield on the shares can go up (or down!).

    Both vehicles have capital gain potential but, as always, be clear on your objective: diversification; or income; or just seeing value in an oversold situation (at which point patience is required)

    Best Regards