Admiral still first rate

On balance, the sector looks like an old banger with a dodgy transmission. However, as seasoned investors will know, pessimism is also an opportunity to lock in good prices for excellent companies. In this context, and following some strong recent half-year figures, we think personal insurer Admiral (ADM) will float a few value investor boats.

Shares in the Cardiff-headquartered multi-line insurer, which generates nearly all its profits from UK motor insurance, have been hammered so far in 2022 and are now down a staggering 37 per cent over the last 12 months. A particularly painful hit arrived last month, after the market digested a profit warning from premium peer Sabre Insurance (SBRE) and concluded that Admiral would face a similarly ugly spike in its combined operating ratio – the insurance industry’s standard measure of underwriting profitability.

However, while no one would argue that Admiral has sailed completely out of trouble, there are signs that the situation is starting to stabilise, beginning with a cautiously well received set of half-year results earlier this month. While these highlighted the problems that all non-life insurers have grappled with this year, there were also grounds for cautious optimism.

Returns maintained

The first sign that the company is coping with the current situation was that it did not follow Sabre in issuing a profit warning prior to the interim results. Second, it stuck to both its regular and special dividends, via 44.2p and 15.8p distributions respectively, together equal to 90 per cent of total earnings for the six months to June. There was also a further 45p dividend paid out of the proceeds of the sale of insurance comparison website division Penguin Portals, which is the final payment from that windfall. In total, Admiral paid out 105p for the half, which if nothing else is a more than adequate “patience payment” for investors prepared to hold the stock.

Indeed, investors tend to value Admiral’s ability to release capital from its reserves to fund special dividends and buybacks. That valuation is rooted in history, given distributions have accounted for two-thirds of the shares’ above-average total return over the last decade.

Reserve releases should continue to prop up distributions. Even after releasing £169mn in the first half of 2022, Admiral’s net claims provision ticked up 6 per cent to £1.72bn. Patently, Admiral can continue to pay out its reserves in the current environment, which means that investors need to differentiate between peers with company-specific issues that do not really affect the rest of the sector.

In fact, a better measure of the current situation might be to compare Admiral’s figures with numbers for 2019. The main impact of the pandemic was to artificially depress the company’s loss ratio, as millions of cars and commercial vehicles idled and claims plunged. That resulted in a drop in the ratio of losses paid to premiums earned (also known as the group loss ratio) to 49.1 per cent in the first half of 2021, before returning to 67.6 per cent this time around. By contrast, 2019’s figure was 69 per cent, so in a sense the latest performance was far closer to the company’s expected average. Where inflation has clearly made its mark is on the group’s total cost ratio. This was 23 per cent in 2019, but 29 per cent at the last results as prices in the claims pipeline – for second-hand cars, repairs, and labour – all skyrocketed in the fallout from Covid-19.

Customers retained

The question now is whether assumptions for an easing in inflation and cost pressures are in line with premium price increases. Car insurance is a competitive sector and some companies have clearly struggled to match premium rates with inflation forecasts. This was why investors took such fright at Sabre’s July profit warning, which many took as a benchmark for the rest of the car insurance sector.

In retrospect, it seems these concerns were overblown, certainly in Admiral’s case. What the market had underestimated was Admiral’s ability to both retain existing customers and acquire new ones. At group level, customer numbers are up 14 per cent over the past year, and 35 per cent since June 2019. The UK business has seen customer growth of 12 per cent to 6.9mn in a year, or 30 per cent compared with 2019. That bodes well for margin expansion once inflation eases back, particularly as Admiral is now the largest UK car insurer with approximately 16 per cent of the domestic market.

As well as underwriting discipline and economies of scale, another reason for Admiral’s recent outperformance of its peers is its more diversified business that can draw on reserves to ensure shareholder payouts. An example of this diversification is the personal lending business, Admiral Money, which writes unsecured personal finance loans. The improving outlook for net interest margins means the segment made its first profit in the half. While not yet material in the context of the insurance business, it does illustrate Admiral’s broader potential for growth in profitable niches, especially when set against analyst estimates for the division’s 30 to 35 per cent return on equity.

One area of concern is the US market, which Admiral entered in 2009. As things stand, the business is never going to trouble the top 10 insurance providers, where Berkshire Hathaway reigns supreme, even if operating in the world’s most evolved car insurance market is likely to provide useful insights for the rest of the group operations. However, with losses accelerating, Admiral faces a choice over whether to continue investing in the US or sell out to a third party. Although the logical conclusion would probably be to cut losses, Admiral is yet to put the business under review. The Italian arm – an unlikely gold mine, given driving habits in the country – is another in need of a turnaround job.

Justified premium

The shares now trade on around 17 times current earnings, broadly in line with the five-year average. However, this reflects a rather cautious set of consensus assumptions around the claims environment and the company’s ability to convert net earned premiums into net profits. It also seems investors have become overly myopic on the near-term knock to the bottom line, given customer growth, excellent returns on tangible equity and analyst estimates of steady net income growth in the years to 2025.

Moreover, investors might do best to let dividends do the talking. Over the past decade, no other constant member of the FTSE 100 has paid out a greater proportion of dividends relative to its 2012 market than Admiral (see chart). That gives the company one of the best total return track records among UK blue chips, on a par with income favourite Legal & General (LGEN) and suggests a good balance between capital returns and growth.

While other non-life peers are cheaper – shares in multi-line general insurer Direct Line (DLG) are priced at 10 times expected earnings – Admiral’s consistent performance, enhanced profitability and market position should give investors more comfort in the years ahead. Therefore, we give Admiral a 21-gun salute.