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By Stuart Watson (TMFTiger)
Being one of the smaller stocks within the Qualiport, news on Independent Insurance (LSE: IIG) tends to be rather thin on the ground. However, yesterday Michael Bright and friends released their interim results. That means today's Qualiport review is going to be heavily Independent-orientated in order to compensate for this.
As discussed in the Qualiport over the last couple of weeks IIG have a pleasant habit of beating analyst expectations when they report results. Unfortunately, this was a habit they broke yesterday, at least in the eyes of the market. When the final results for 1998 were published in April of this year the company was very bullish about its prospects. It cited factors such as hardening insurance rates and a general increase in the volume of available business. IIG expected this latter effect to be magnified as brokers now had fewer companies through which to place their business, following the recent consolidation of the industry.
The company's optimism fed through to the share price which has risen from just over 200p in late November to over 300p earlier this month. Perhaps because of these high expectations, investors were disappointed with yesterday's offering. Despite this latest fall the share price sits handsomely above its float price of 50p back in October 1993. Since then the share has risen at a compound annual growth rate of 45%, and that's highly impressive.
Yesterday's results showed pre-tax profits falling from £45.6m last year to just £24.6m for the first six months of 1999. As always, with IIG you need to analyse the profits on two levels. Firstly, there is the core underwriting business. Secondly, there are the investment returns from the company's 'float' of investments and cash.
The underwriting business appears to be going great guns, backing up many of the company's statements made earlier this year. Underwriting profit was up 60% to £17.3m on net premiums earned, up 10%, of £203m. This means IIG made 8.5p for each £1 of premiums earned in the first six months of the year. In 1998, the year when the company faced many weather-related losses, it made 6.7p for every £1. The previous year it made 6.2p. It's good to see a rising trend.
It appears that IIG's recent growth in underwriting profits has primarily been margin-based rather than volume-related. In short, they have either managed to push up their prices and/or are selecting their business more carefully, resulting in lower payouts. The interim commentary also refers to considerable growth in new business, up to 70% in some classes, which is yet to feed through into the profit figures. Let's hope this new business continues at the same level of profitability.
IIG is one of the few insurance businesses where the company sets out its stall very firmly with respect to underwriting. Most insurance companies look to do no better than break even on their core business. For growth, they rely upon increases in their cash and investments. Take the UK personal motor insurance industry. It is estimated that this market will lose £600m for 1998 on total premiums of £6b. This means that these companies are losing 10p for each £1 of premium earned. Compare that to IIG. Also don't be surprised if your car insurance is significantly more expensive when you come to renew your policy.
The other insurance business with a similar approach to IIG is GEICO of the United States. This is owned by someone you may have heard of, a certain Warren Buffett. Interestingly, personal motor insurance is one of GEICO's strongest areas. In the UK, it's an area IIG appears keen to stay well away from.
Talking of Warren Buffett, it now seems appropriate to turn to the performance of IIG's own investments. In the first six months of 1999 combined realised and unrealised net losses were £1.3m. In the corresponding period in 1998 they made a £22m net gain from their investments. This turnaround is the principal cause of the decline in the headline profit numbers.
IIG's float is now around £400m as opposed to £500m this time last year. Obviously, with a smaller float, returns from that float are likely to be lower as well. IIG has an investment policy of 25% in equities, 10% in property and the remaining 65% in fixed interest investments (i.e. gilts and bonds) and cash. Bruce Jackson (TMFGoogly) attended yesterday's analyst briefing on the results and noticed the low profile given to the investment side of the business. However, you can hardly expect us, at the Motley Fool, not take a keen interest in this area of operations.
Given the bias towards bonds in IIG's investments it is not surprising that recent years have seen impressive returns. In 1997, gains were £36.2m and in 1998 they were £40.1m. Equally, it is not surprising that the last six months have seen more sedate returns. Bonds have struggled due to the fear of rising interest rates. The performances of 1997 and 1998 were never going to continue indefinitely.
Over the long run returns from investments are likely to fall to between the level seen in 1998 and the roughly break-even level seen in the first six months of 1999. Where in this range it will end up is one of the key questions we need to assess in any valuation of IIG. But I'll leave that tricky bit to Bruce as he's got the spreadsheet set up already. I'd hate to step on his toes.
The final piece of the IIG puzzle we need to consider is cash flow. Strong cash flow is important for two reasons. Firstly, cash flow is lot harder to manipulate than profits. Secondly, companies with good cash flow can fund their own expansion and do not need to return, cap in hand, to shareholders or bankers.
After three years of strong cash flow from 1994 to 1996, IIG's operating cash flow has been significantly below operating profits in 1997 and 1998. Over the last five years, however, total operating cash flow has been £283m, compared with operating profits of £274m so, overall, IIG is still ahead on cash terms. The interim results showed a cash outflow from operating activities of £21.3m. However, as you may have already seen from Bruce's message board posts, management is predicting this trend will reverse, starting in the second half of this year.
As I mentioned above, Bruce will be plugging these latest numbers into his spreadsheet. To me, it doesn't look like there is much change in the IIG story. Will the Qualiport 'accumulate' or 'hold'?
Moving on to other news from the Qualiport world. EMAP (LSE: EMA) had a share price wobble today as the Audit Bureau of Circulation (ABC) reported that average sales of FHM had fallen 10% in the first half of 1999 to 701,000 copies, due to a proliferation of me-too competitors. We called EMAP, and a spokesman for the company told us "EMAP is run for profitability, not for ABC's headline figures".
Dell Computer Corporation (NASDAQ: DELL) had a little wobble on Thursday as analysts highlighted concerns over free PCs in the US and their long-term impact upon sales. Some of them believe that the average prices of Dell's PCs will fall 9% this year and 11% next year. The smaller players in the PC market are predicted to suffer even greater falls.
Comments and questions to the Qualiport board, please.
Finally, the latest Qualiport numbers.
Company Change Bid DELL(US)-2.00 40.10 EMA -0.59 10.67 IIG -0.06 2.96 MSY +0.03 5.46 PIZ +0.22 7.07 RTO +0.09 2.43 ULVR +0.02 5.86 Qualiport Stocks Last Rec'd Total # Company Buy Current Change 27/10/98 755 Indep Ins 2.58 2.96 14.7% 19/12/97 783 Rentokil 2.55 2.43 (4.7%) 22/04/99 347 Misys 5.76 5.46 (5.2%) 17/04/98 169 EMAP 11.34 10.67 (5.9%) 27/01/99 74 Dell (US) 44.63 40.10 (10.1%) 04/11/98 245 Pizza Exp 7.93 7.07 (10.8%) 17/07/98 266 Unilever 7.53 5.86 (22.1%) Last Rec'd Total # Company In At Value Change 27/10/98 755 Indep Ins 1972.64 2234.80 262.16 22/04/99 347 Misys 2028.71 1894.62 (134.09) 19/12/97 783 Rentokil 2046.53 1902.69 (143.84) 17/04/98 169 EMAP 2341.32 2155.34 (185.98) 27/01/99 74 Dell (US) 2007.42 1798.42 (208.99) 04/11/98 245 Pizza Exp 1966.34 1732.15 (234.19) 17/07/98 266 Unilever 2052.00 1558.76 (493.24) Cash: £3,433.46 Current Total : £16,710.25 Total Invested: £18,184.62 Profit/(Loss) : (£1,474.37) Value Per Share Day Month Year Qualiport -0.68% -1.54% -11.15% FTSE 100 1.49% 0.21% 6.16% FTSE All Share 1.28% 0.23% 9.65%