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Bid hopes to buoy high-yielding Lancashire

Not only does Lancashire boast a fat dividend, but bid rumours look set to buoy the shares
January 15, 2015

News late last month that New York-listed insurer XL Group (US:XL) had made an approach for Lloyd's underwriter Catling (CGL) has helped fuel speculation that wider sector consolidation could be on the cards. At present, insurance analysts mainly think that deal-doing in the UK is more likely to manifest itself through bolt-on acquisitions among the sector's smaller players and, crucially, mid-sized Lancashire (LRE) is being mooted as a potential target. Add that to the group's fairly modest share price rating, as well as its impressive dividend prospects, and snapping up Lancashire's shares now could prove lucrative.

IC TIP: Buy at 557p
Tip style
Speculative
Risk rating
High
Timescale
Long Term
Bull points
  • Potential bid target
  • Solid underwriter
  • Impressive dividend prospects
  • Shares undemandingly rated for the sector
Bear points
  • Premium rates under pressure
  • Former boss's departure has hurt sentiment

The arguments in favour of consolidation are certainly sound. Significantly, after several years without big costly catastrophe claims, insurers have more than enough capital to fund deals. What's more, that capital glut is also driving down premium rates as underwriters compete on price and such a relatively depressed market backdrop is making consolidation look more attractive. "Surplus capital will inevitably accelerate M&A," notes insurance analyst Joanna Parsons of broker

 

 

Westhouse Securities. "A typical reaction to constrained growth and large balance sheets is that, if you can't get it organically, you buy it." She names Lloyd's insurer Novae (NVA) - but also Lancashire - as "easy to swallow deals". XL's offer for Catlin was set at about 1.5 times analysts' forecasts for end-2014's net tangible assets (NTA). Applying a similar multiple to Lancashire's shares implies a takeout price of over 620p, or roughly 11 per cent above the current share price.

LANCASHIRE HOLDINGS (LRE)

ORD PRICE:557pMARKET VALUE:£1.05bn
TOUCH:556-557p12-MONTH HIGH/LOW:695p506p
FWD DIVIDEND YIELD:9.5%FWD PE RATIO:9
NET ASSET VALUE:809¢COMBINED RATIO:74.5%

Year to 31 DecGross premiums ($m)Pre-tax profit ($m)Adj. earnings per share (¢)Dividend per share (¢)*
201163221912095
2012724237129210
201368021811780
2014*91418891135
2015*8301849180
% change-9-2--41

*Westhouse Securities forecasts, includes special dividends

Normal market size: 3,000

Matched bargain trading

Beta:0.68

£1=$1.51

Even if a deal doesn't materialise - and Lloyd's is littered with past failed bid attempts - the group's robust underwriting record still leaves Lancashire looking attractive. Indeed, the company reported a highly profitable combined ratio (comparing claims to premiums) of nearly 75 per cent for the nine months to end-September 2014 - that's a notably better underwriting performance than at most of its peers, which typically report ratios in the mid-80 per cent range. Moreover, the group is managing to deliver that robust underwriting result despite an increasingly soft pricing backdrop: in the first nine months, for instance, Lancashire's premium rates for property retrocession and reinsurance cover fell to 87 per cent of the levels achieved a year earlier. Such pricing slippage, however, is entirely in line with the sector's wider experience.

With rates under pressure, analysts also expect Lancashire to continue to return capital to shareholders that it can't profitably utilise and that signals excellent dividend prospects. In fact, Westhouse anticipates end-2014's total dividend - the base dividend plus special dividends - to reach a chunky 135¢ (89p), implying a prospective yield of 16 per cent. Even for the historically high-yielding insurance sector, that's a fat payout: the average prospective yield for the sector is nearer 6 per cent according to broker Numis Securities.

True, sentiment towards Lancashire's shares has suffered after founder Richard Brindle said he was stepping down as chief executive back in April - he was replaced by former chief underwriting officer Alex Maloney. That sentiment problem has been compounded by rumours that Mr Brindle is looking to launch a new rival insurer during the course of this year as it's feared he could poach business and staff from Lancashire.