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Admiral's motor set to stall

SHARE TIP: Admiral (ADM)
October 7, 2010

BULL POINTS:

■ Market-beating underwriting performance

■ Premiums have been rising fast

BEAR POINTS:

■ UK motor market could slow

■ Shares most business with reinsurers

■ Company difficult to value

■ Looks expensive on a sum-of-parts basis

IC TIP: Sell at 1664p

Motor insurer Admiral reported good news with its first-half figures in August. Its premium rates jumped 14 per cent at a time when most insurers are struggling just to stop rates from slipping. And it managed a decently-profitable combined ratio (of claims to premiums) of 89 per cent . That’s not bad considering the UK motor market has been hit with heavy losses – the market average combined ratio stands at 122 per cent. Admiral is growing fast, too, with customer numbers up 23 per cent year-on-year.

IC TIP RATING
Risk ratingHigh
TimescaleLong-term
What do these mean? Find out in our

But, after grabbing an 8-9 per cent share of the UK motor market, most City analysts expect Admiral's rapid expansion to slow. Most think it won't ever take more than 15 per cent of the market. Admiral’s progress with premiums isn't unique either – insurer Brit, for instance, reported a 10.5 per cent increase in its motor rates in the first half. Rather, such hefty hikes reflect the need for motor insurers to rebuild their reserves after suffering heavy losses. Yet, as reserves are replenished, such impressive rate increases will be hard to maintain. “[Market] rate increases are currently in excess of 20 per cent, but we doubt how sustainable this level will prove,” say analysts at broker Jefferies International. Essentially, the best of the motor upturn could have already passed.

Besides, Admiral's ability to benefit from today's firm motor rates is limited by its arrangements with a group of reinsurers. Admiral keeps just 27.5 per cent of its UK premiums, with the remainder being passed on to reinsureres, such as Munich Re, Hannover Re and Swiss Re. Admiral's bosses insist that the terms "in all the agreements allow Admiral to participate to a large extent in the profitability of the total underwriting". Nonetheless, such deals leave Admiral sharing much of its profits, though it also shares out the losses with the reinsurers.

The group's price comparison website, confused.com, isn't doing so well, either. In the first half, its operating profit fell 35 per cent year-on-year to £7.1m amidst tough competition. Specifically, rivals comparethemarket.com and gocompare.com are thought to have run better TV advertising campaigns. Admiral is planning a new advertising campaign later this year, but taking back the ground lost to comparethemarket’s meerkats and gocompare’s opera singer won’t be easy. Meanwhile Admiral's fledgling overseas operations – such as AdmiralDirekt in Germany or Balumba in Spain - are either loss-making, or barely breaking even.

ORD PRICE:1,662pMARKET VALUE:£4.47bn
TOUCH:1,662-1,664p12-MONTH HIGH/LOW:1,686p990p
DIVIDEND YIELD:3.3%PE RATIO:24
NET ASSET VALUE:120pCOMBINED RATIO:89%

Year to 31 DecNet premiums written (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
200614514739.836.1
200714218248.643.8
200817020354.952.5
200921221659.057.5
2010*27726270.055.5
% change+31+21+19-3

* Jefferies International estimates

Normal market size: 3,000

Matched bargain trading

Beta: 0.4

In addition, Admiral's reinsurance partnership structure makes valuing its shares difficult. Comparing an insurers' share price to a forecast for net tangible assets (NTA) is the usual touchstone and, at present, most insurers' shares trade at around expected NTA. But, as most of Admiral’s business is underwritten by reinsurers, it needs less capital, meaning that its NTA is much lower than at its rivals. That explains why Admiral's shares trade at a fairly-meaningless 13 times full-year estimates of NTA from broker Numis Securities. Clearly, another valuation method is needed.

Instead, a sum-of-the-parts analysis looks sensible and one such approach involves applying typical market PE ratios to Admiral's various businesses. Taking rival RSA's PE ratio of about 10 times as a benchmark, and adjusting to reflect Admiral's better performance, leaves Numis Securities applying a ratio of 11 times to the group's UK underwriting operation. The broker then applies a ratio of 13 times to Admiral's ancillary income. That, says Numis, yields a total value of 1,171p a share for the UK insurance business. In a similar way, the broker calculates confused.com as being worth 66p a share, with European growth potential adding another 42p. The trouble is these give a total of 1,279p - 23 per cent below the current share price.