Intact Financial report

Intact Financial Corporation (ITC, Toronto)

RESEARCH SUMMARY

Report Author(s):

InvestorsFriend Inc. Analyst(s)

Author(s)’ disclosure of share ownership:

 The Author(s) hold no shares

Based on financials from:

2019 Y.E.

Last updated:

April 15, 2020

Share Price At Date of Last Update:

 $                            138.70

Currency:

$ Canadian

Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual):

Weak Buy / hold at $138.70

Has Wonderful Economics?

Moderately Good

Has Excellent and Trustworthy Management?

Yes

Likely to grow earnings per share at an attractive rate over the next decade?

Maybe

Positive near-term earnings outlook?

Uncertain

Valuation?

Somewhat Expensive

SUMMARY AND RATING:  The graph of revenues (Direct Written Premiums in this case) per share (red line) shows  very strong and steady growth Earnings per share have been volatile as they are affected by non-operating gains and losses as well as by unusual losses such as due to storms in some years. The Value ratios would indicate a rating of no higher than Weak Buy / Hold as the P/E of 27 is not attractive. Management quality appears strong . The insider trading signal is neutral. The near-term outlook is hard to forecast given the economic shutdown – claims should be way down, but customers are asking for and receiving premium reductions as their vehicles are idle. The medium term could see an earnings decline due to recession conditions. Growth should resume in the longer term. The economics of the business have been good but not excellent with the ROE around 10% – but the long term track record has been quite good. It has some competitive advantages in terms of scale. Overall we would rate this as a Weak Buy / Hold at $138.70.

LONG TERM VALUE CREATION: Strong

DESCRIPTION OF BUSINESS: Intact is the largest provider of property and casualty insurance in Canada where it distributes mostly through brokers but also has some direct-to-customer sales through its belairdirect division. It also provides speciality commercial insurance in the U.S through independent brokers, wholesalers and managing general agencies. The company has about 16,000 employees serving 5 million customers.

ECONOMICS OF THE BUSINESS: The economics have been quite good although not exceptional based on the historic ROE at around 10% in the past four years but usually in the low teens prior to that.

RISKS: They always face the risk that they have under estimated the claims costs that will develop but they have a strong history in that regard. In 2020 there may be a  risk that people will begin to reduce the insurance on their vehicles or reduce the vehicles per household if the shutdown continues too long. Overall, the risks seem manageable.

INSIDER TRADING / INSIDER HOLDING: Checking from January 1, 2020 to April 14, 2020: Only two insiders sold shares. One sold about half his shares in mid February at about $152. Another sold 12% of his shares selling on February 6 and a lesser amount February 24. During this period about 20 insiders received shares through rights . Overall with little selling, the insider trading signal is neutral.

WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: The business is  simple to understand and predict (marginal pass because its business is familiar but  the earnings are subject to estimates and random impacts that can be large), has favorable long-term economics due to cost advantages or superior brand power (pass due to scale as it is the largest in Canada and based on its track record of doing better than the industry average), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (marginal pass at best based on value ratios), Other criteria that have been attributed to Buffett include: a low  debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (pass)

MOST RECENT EARNINGS AND SALES TREND: The increase in Gross Written Premiums (their preferred measure of revenue) in the past four quarters beginning with the most recent (Q4) was 11%, 11%, 8% and 6%. In 2019 overall the growth was 9%. Earnings per shares, especially on a quarterly basis, are more volatile due to non-operating gains and losses. In the past four quarters, starting with Q4,  the change was minus 3%, minus 6%, 6% and 56%. In 2019 overall the growth was 6%. Overall the revenue and earnings trend was positive at the end of 2019.

COMPARABLE STORE SALES  OR INDUSTRY SPECIFIC STATISTICS: In insurance, the “combined ratio” is highly important as it shows the profit level on insurance before adding any profit from investments. The lower the number the better. Traditionally the industry struggled to get much under 100%. Intact however has had a strong combined ratio that was quite steady at around 95% for the past four years.

Earnings Growth Scenario and Justifiable P/E: The current P/E of 27 appears to be pricing in annual earnings growth of about 11% assuming the P/e will decline to about 20.

VALUE RATIOS: Analysed at $138.70. The price to book value ratio may be somewhat unattractively high for at 2.5. The price to earnings ratio seems unattractively high at 27.3. The forward P/E based on analyst estimates would be attractive at 15.7 but it’s not apparent to us why the earnings would surge 74% to make that happen. The dividend yield is modest at 2.4%. The ROE is good at 10%. Revenues (Direct Written Premiums in this case) have compounded up at an average of 7.3% in the past five years and Earnings per share have compounded up at 6.1%. With the P/E at 27 we would assume that it will trend down closer to the market average. A growth assumption of 6% and the P?E declining to 18 in five years results in an intrinsic value calculation of just $103. 10% annual earnings per share growth with the P/E declining to 20 in five years results in an intrinsic value calculation of $135. Overall the value ratios would suggest a rating of no better than Weak Buy / Hold.

SUPPORTING RESEARCH AND ANALYSIS

Symbol and Exchange:

Intact Financial Corporation

Currency:

$ Canadian

Contact:

ir@intact.net

Web-site:

www.intactfc.com

INCOME AND PRICE / EARNINGS RATIO ANALYSIS

Latest four quarters annual sales $ millions:

$11,049.0

Latest four quarters annual earnings $ millions:

$709.0

P/E ratio based on latest four quarters earnings:

27.3

Latest four quarters annual earnings, adjusted, $ millions:

$709.0

BASIS OR SOURCE OF ADJUSTED EARNINGS: No adjustments were made. There were likely some unusual gains and losses but Apple does not discuss any in the annual report.

Quality of Earnings Measurement and Persistence: Reasonable quality. There has been quite strong persistence. Earnings are subject to estimating claims liabilities which does mean that the reported earnings are ultimately something of an estimate.

P/E ratio based on latest four quarters earnings, adjusted

27.3

Latest fiscal year annual earnings:

$709.0

P/E ratio based on latest fiscal year earnings:

27.3

Fiscal earnings adjusted:

$709.0

P/E ratio for fiscal earnings adjusted:

27.3

Latest four quarters profit as percent of sales

6.4%

Dividend Yield:

2.4%

Price / Sales Ratio

1.75

BALANCE SHEET ITEMS

Price to (diluted) book value ratio:

2.52

Balance Sheet: Assets are composed as follows: 58% are investments (of which 64% are debt securities, 22% are common shares, 8% are preferred shares and 5% is cash). 15% of the assets are goodwill or the equivalent. 11% is premiums receivable. 5% is reinsurance assets. Just 3% is property and equipment including software which illustrates the financial as opposed to physical nature of this company. The remaining 8% is a number of items including deferred acquisition costs, other assets and investments in associates. On the other side of the balance sheet these assets are supported and finances as follows: 55% by estimated claims liabilities and unearned premiums, 11% by a hodgepodge of other liabilities, 24% by common equity and 3% by preferred share equity. This is a strong balance sheet. The goodwill is relatively modest and the debt is not excessive.

Quality of Net Assets (Book Equity Value) Measurement: Reasonable quality although the level of claims liabilities is very much an estimated number and higher than estimated claims would erode the net book value.

Number of Diluted common shares in millions:

                                140.4

Controlling Shareholder:

Market Equity Capitalization (Value) $ millions:

$19,473.5

Percentage of assets supported by common equity: (remainder is debt or other liabilities)

23.9%

Interest-bearing debt as a percentage of common equity

31%

Current assets / current liabilities:

not disclosed

Liquidity and capital structure: Strong liquidity, see comments on Balance Sheet. They have a high credit rating including a minus on unsecured debt from A.M. Best.

RETURN ON EQUITY AND ON MARKET VALUE

Latest four quarters adjusted (if applicable) net income return on average equity:

9.8%

Latest fiscal year adjusted (if applicable) net income return on average equity:

9.8%

Adjusted (if applicable) latest four quarters return on market capitalization:

3.6%

GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE

5 years compounded growth in sales/share

7.2%

Volatility of sales growth per share:

 $                                  –  

5 Years compounded growth in earnings/share

-3.1%

5 years compounded growth in adjusted earnings per share

-3.1%

Volatility of earnings growth:

 $                                  –  

Projected current year earnings $millions:

not available

Management projected price to earnings ratio:

not available

Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in earnings per share?

Yes

Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained:

3.3%

More conservative estimate of compounded growth in earnings per share over the forecast period:

6.0%

More optimistic estimate of compounded growth in earnings per share over the forecast period:

10.0%

OUTLOOK FOR BUSINESS: The very near-term should be quite positive as claims should be way down due to the shutdown. Profits should be up even if some customers receive partial refunds. Rather than blanket refunds, the company has announced it will reduce premiums and allow deferred payments on a request basis including a 75% reduction on autos that are stored / secured  and taken off the road, but this is only until June 30. Overall, like most companies the net impact on Q2 is unknown.

LONG TERM PREDICTABILITY: The company has a very strong track record and can likely continue to grow. However, given the shutdown and a slow emergence from it they could possibly face declining earnings in the medium term.

Estimated present value per share: We calculate  $103 if adjusted earnings per share grow for 5 years at the more conservative rate of 6% and the shares can then be sold at a reduced P/E of 18 and $135 if adjusted earnings per share grow at the more optimistic rate of 10% for 5 years and the shares can then be sold at a reduced P/E of 20. However, if the P/E can stay at 27 (which seems aggressive) then a 6% growth would result in a value of $145. Both estimates use a 7.0% required rate of return.

ADDITIONAL COMMENTS

INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (marginal pass at best as barriers are low). No issues with powerful suppliers (pass, they don’t rely on suppliers). No issues with dependence on powerful customers (pass, as they are apparently not reliant on any one broker to any great extent), No potential for substitute products (pass, insurance is needed and largely mandated) No tendency to compete ruinously on price (marginal pass, the industry can get competitive on price at times). Overall this industry appears to be attractive for a large incumbent.

COMPETITIVE ADVANTAGE: Scale and specialization.  Existing stable of attractive locations. The entrepreneurial de-centralized structure appears to be a real strength and allows them to integrate purchased stores quickly.

COMPETITIVE POSITION: Intact is the largest provider of property and casualty insurance in Canada.

RECENT EVENTS: In Q4, 2019 the dividend was increased by 9% and this was the fifteenth consecutive annual increase since the IPO in 2004. Three relatively small acquisitions were made in Q4 2019.

ACCOUNTING AND DISCLOSURE ISSUES: The disclosure appears to be excellent. A minor complaint is that they show net income before deducting preferred share dividends.

COMMON SHARE STRUCTURE USED: Normal, one vote per share.

MANAGEMENT QUALITY: Appears to be strong

Capital Allocation Skills: They appear to have invested in profitable lines of business.

EXECUTIVE COMPENSATION:

BOARD OF DIRECTORS:

Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed  analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry.

DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice.

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