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More re-rating potential at Novae

As Lloyd's insurer Novae continues to boost its historically weak return on equity, expect its shares to re-rate towards the sector average
October 2, 2014

For years, Lloyd's insurer Novae (NVA) has suffered a weaker return on equity than most of its peers and that has hit sentiment. But management has worked to improve that return, and further progress looks likely next year. Add that to Novae's impressive underwriting record and its potential as a takeover target and the shares should continue to re-rate to come more into line with rivals.

IC TIP: Buy at 539p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points
  • Scope to boost return on equity
  • Solidly profitable underwriter
  • Could be a takeover target
  • Shares cheaply rated for the sector
Bear points
  • Premium rates under pressure
  • Modest dividend yield for an insurer

Between January 2006 and June 2009 Novae's average post-tax return on equity reached just 8 per cent compared with around 14 per cent for its listed peer group. Management's first big move to address that came in early 2010 when the liabilities of Novae's non-Lloyd's operation were transferred to the Lloyd's business. That allowed for the release of nearly £33m of regulatory-related capital (returned as a 45p special dividend). Consequently, Novae's annualised return on equity had reached almost 14 per cent at this year's half-year stage and its shares rating to net tangible assets (NTA) has responded in kind (see table).

Novae's slow re-rating
CompanyEnd-Dec 2009 RoEPrice/reported NTA (end-2009)End-June 2014 RoEPrice/reported NTA (end-June 2104)
Amlin37%1.216.2%1.6
Beazley17%0.917%1.9
Catlin24%0.917.1%1.2
Hiscox30.1%1.418.9%1.8
Novae5.8%0.813.8%1.1
Source: Company reports

But there could be plenty more to come. Novae's return on equity remains nothing special: rival Hiscox's (HSX), for example, reached almost 19 per cent at the half year. Novae's management is set to bolster the return further during 2015.

Specifically, Novae has been benefiting from a deferred tax asset relating to losses incurred over a decade ago. But taking advantage of that also stopped the company from following the example of many Lloyd's peers that redomiciled offshore to take advantage of more attractive tax regimes. That benefit, however, should end by the year-end, leaving Novae free to explore a more efficient tax structure. In fact, just this month the company received approval to launch a Bermudan business. True, that's not the same as a full redomicile but some analysts don't think Novae will need to pursue that option to deliver a better tax rate.

NOVAE (NVA)

ORD PRICE:539pMARKET VALUE:£347m
TOUCH:535-539p12-MONTH HIGH:642pLOW: 480p
FORWARD DIVIDEND YIELD:4.4%FORWARD PE RATIO:12
NET ASSET VALUE:470pCOMBINED RATIO:91%

Year to 31 DecGross premiums (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
2011606-6.3-11.818
201261239.943.020
201359042.849.022.5†
2014*62237.145.322.7
2015*64937.446.323.8
% change+4+1+2+5

*Numis Securities estimates

Normal market size: 500

Matched bargain trading

Beta: 0.39

†Excludes 20p special dividend

Novae is among the sector's most profitable underwriters, too, and it reported a solidly profitable 91 per cent combined ratio (of claims to premiums) at the half-year stage. Inevitably, that performance was helped by the absence of big loss-inducing claims. In fact, 2011 was the last year of really significant losses when a string of major catastrophes delivered a globally insured loss of around $105bn (£64bn).

But while that benign claims backdrop is great news for short-term earnings, it also leaves underwriters overcapitalised and tempted to compete by cutting premium rates - bad news for longer-term earnings. Premium rates are therefore sliding, and at the half-year stage Novae reported that rates on US catastrophe business has slumped 14 per cent while its aviation reinsurance and general liability books suffered 11 per cent and 12 per cent rate declines, respectively. Still, rates are falling from sufficiently high levels to keep the profits rolling in and broker Numis Securities expects Novae's combined ratio to remain at roughly its current level until end-2015.

That backdrop has also left insurers with more capital than they can utilise. For many that's likely to prompt special dividends, although Novae is thought less likely to serve up such distributions. And while its shares still yield over 4 per cent on a prospective basis, that's modest for the sector. Those of Brit (BRIT), for example, yield 14 per cent based on Numis's full-year forecast payout. Some may use their excess capital, however, to fund acquisitions. If so, Joanna Parsons of broker Westhouse Securities believes the "most obvious targets" include Novae, one of the sector's smaller players.