Description

Summary

Since my post in May 2018, Admiral shares have compounded at 13% CAGR and recently reached all-time-highs after 1H24 results. After pulling back in recent weeks, at £8.6bn of market cap, Admiral remains very cheap.

This is the 5^th post on Admiral on VIC, which perhaps goes to show that great compounders tend to trade at a discount to their intrinsic value.

The business has moved from a consensus “sell” to a consensus “buy” in recent years:

Source: Bloomberg

Yet, despite material earnings upgrades through 2024, the market is underestimating the earnings power of the business, particularly UK Motor Insurance. In a way, this is by design: management refuse to offer guidance and are reluctant to engage in speculative requests for precise forecasts on inflation, loss ratios, profit commissions, etc.

To illustrate, ahead of 1H24 results on the 15^th of August, consensus numbers for UK Motor FY2024 Total premiums written were £3,481m. The actual figure for the 1H24 was £2,403m, thanks to 11% policy count growth to 5.48m and much higher average premiums, which annualizes 38% above consensus estimates.

To be fair, consensus has gotten better at understanding the drivers of Admiral’s business, even if they remain fixated on immediate perceived “risks” and underestimate the way Admiral thrives in the complexity of each cycle, responding to regulator’s curve balls and inflationary (or deflationary) shocks as we saw between 2021 and 2023, and before that in 2020 with COVID. As David Stevens, co-founder and former CEO, wrote in the 2011 FY report (when he was COO):

“.. What does the future hold? The headlines (unusually in the popular press, as well as the trade press) are dominated by the current slew of actual and potential legislative and regulatory change: the Competition Commission, hot on the heels of the OFT enquiry, the Jackson reforms, possible further changes to the administration of, and costs associated with bodily injury claims, the banning of gender-based rating, the newly-formed Financial Conduct Authority's focus on value for money add-ons.

But it's not the ultimate outcome of this frenetic activity that will determine the health of Admiral's core UK operation in twenty years' time. Current and proposed changes, as long as they're implemented and enforced even-handedly and universally across the market, don't affect relative competitive strength, over anything but the very short term. Nor do they affect overall industry profitability. It is, as it has always been, the ability to execute better than others in dozens of individually insignificant, but collectively important, ways, and to respond to fundamental underlying changes more quickly and more adeptly than competitors that will be the key to future success" 

I think Admiral shares are worth at least £40/share under conservative assumptions, almost 45% above the current share price. This is too cheap to ignore and I would recommend buying at £28/share.

Why this again?

To understand why Admiral remains cheap today, despite being close to its all-time-high, it’s important to revisit the way it recognizes profit. As part of the transition to IFRS 17 last year, Admiral added more disclosure (take a look at the FY23 results presentation, which includes very helpful examples - PowerPoint Presentation (admiralgroup.co.uk) and  the IFRS17 session presentation from late 2022 - Admiral Group plc FY2020 Results)

Around 80% of a profitable Underwriting Year’s profits are recognized in the first 5 years, with the total taking up to 10 to flow through the P&L. The first 2 years are key, given up to 2/3rds of the profits will have been recognized already. Admiral can choose to commutate business written under its quota-share insurance deals after Year 3. Profit commissions on its co-insurance agreements are earned throughout depending on the Combined Ratio progression (importantly, since 2022, Admiral keeps 75% of profits under “typical” Combined Ratios, compared to 65% before).

2021 and 2022 are Unprofitable Years (so far, though management say they have never had an unprofitable year and don’t expect either of these to be the first). 2023 and 2024 are Profitable Years. What matters, after all, is the cumulative margin of the total premium written by Admiral by Underwriting Year. Between 2014 and 2020 –mature years, although some are still earning - Admiral achieved an average of 29% cumulative PBT margin on each Underwriting Year. See below for the 2017-1H24 period:

Source: 1H24 Results presentation

Cristina Nestares, UK Insurance CEO, mentioned during the FY23 results call: In order to answer margin today I just want to go back a couple of years. When you look at '22, it was possibly the worst year in our history, highest loss ratio. So it's been a time of adjustment. The margins that we believe, because it takes some time to develop, that we're writing business at the moment is basically going back to more normalized margin levels, pre-Covid levels.

We're constantly adjusting rates. I mean -- so when I talk about a small decrease at the end of the year, it's because we saw some better claims conditions and made a small adjustment. But it doesn't fundamentally change our margins. We're still looking into more standardized margins."

2023’s initial Ultimate Loss Ratio pick was 94%, but already at 1H24 the expected Ultimate Loss Ratio was 85%. For 2024, the initial 1H24 pick was 79%.

In judging where Admiral’s business will be in 12, 24 and further out months, analysts and investors should be trying to answer a few simple questions:

• What will 2024’s Total Written Premiums in UK Motor be?

Likely close to £4.5bn. Admiral put rates up in March 2024 and as of August it had not reduced them, becoming less competitive, but still expecting to grow policy count and premiums in 2H24.

In September, Consumer Intelligence’s Personal Motor Pricing Index shows that New Business quotes were flat in the three months to August and remain 9.4% higher YoY. The ONS monthly CPI data for Motor Insurance showed stabilisation in premiums during August as well, following a small decline in July and June. ABI data showed prices for New Business fell around 1.7% in 2Q24.

Considering that average premiums increased 34% in 2023, the data does not show premiums falling in a meaningful way. They shouldn’t really: claims inflation expectations remain high. Sabre talking about 12%, Hastings about 10%, Direct Line low-double digits and Admiral high-single digits.

• What does history tell us about Admiral’s average PBT margin per underwriting year?

You could assume 29%, as mentioned before. For conservativeness assume 25%, but keep in mind management mentioned they expect ultimate Loss Ratios for 2023 and 2024 to be similar. 2023’s initial Ultimate Loss Ratio pick was 94% and it has already improved 900bps, but 2024s initial’s pick was 79%. Consider also a very good year like 2020, with an initial Ultimate Loss Ratio pick of 74%, which has improved 17pp to 57%. At a 25% margin, 2024 could generate over £1.1bn of PBT to Admiral cumulatively in the next few years. If correct, this translates into an 11% PBT CAGR over 10 years and 13% since IPO. Not bad for a mature insurance operation.

• Will 2025 and beyond premiums fall off a cliff?

Unlikely. As mentioned above, premiums are not falling off a cliff, but more importantly, Admiral’s strategy of offering multi-cover policies is bearing fruit: retention, already above market average, keeps improving, and the General Insurance Pricing (GIP) reforms that prevent insurers from using their back-books to subsidize new business growth may lead to even higher retention across the market.

Inflation is unlikely to fall off a cliff. Although frequency remains 10% below pre-pandemic levels, the general trend of car prices is upwards given the technology embedded and a higher share of EVs in the mix, which cost more to fix. Also, the cost of care – which influences the cost of large bodily injury claims – is going up: hourly wages in the care sector increased 8.1% on average in 2023 compared to 7.7% in 2022.

Admiral believes that the combination of COVID, supply-chain inflationary shocks and a major regulatory reform like the FCA’s GIP, all of which happened in the course of 3 years, is unlikely to repeat soon (I agree!) Therefore, market cycles should be softer.

Overall, I think investors should give credit to the way Admiral – once again – navigated this cycle, flexing prices ahead of competitors in order to gain market share when it was appropriate: their market share of policies increased from ~14% in 2021 to 17% in 1H24 and I see no reason why this should not increase further. In this particular point, sell-side has consistently undershot.

In any case, the prudent approach is to expect average premiums to decline moderately, and Admiral’s policy count to grow at a slower pace too. Positively, there is only one year in the last 21 – 2022 – when policy count fell 0.6%. Potentially offsetting this risk in coming years is the expectation of Admiral’s confidence level for reserving purposes coming down gradually from around the 93^rd percentile today to 90^th, accelerating profit recognition. For reference, Direct Line’s reserves at a 75^th percentile, and Sabre, more prudently, at ca. 82^nd percentile.

Remember also that Admiral’s approach to the cycle shows accelerated HSD to LDD policy-growth spurts followed by periods of LSD growth.

There was a 17% cumulative decline in written premiums between 2013 and 2014, which could be a worst-case scenario in the next five years if competition intensifies, but even then, I would expect UK Motor to deliver ca. £1bn of PBT on a normalized basis, against a Solvency base of ~£1.4bn and total Equity of £1.1bn as of 1H24.

Source: Admiral

So how much is UK Motor worth?

At 12x PBT multiple, the UK Motor business is worth at least £12bn. Deduct £0.25bn of subordinated bonds and charge ~£1bn of capitalized overhead and you get £10.75bn of equity value for the UK motor business alone, which is 25% above the current market cap. In addition, I estimate ca.

£850m of excess reserves (10% of current market cap). In addition, Admiral may not need as much Solvency capital as it has today once its Internal Model is finally approved (no line of sight on when this may happen, other than the fact that they have submitted a pre-application to the regulator during 1H24)

Simplistically, assuming zero value for everything else, the business trades at ca. 10x my 2024 estimates of UK Motor after-tax earnings.

And there is more.

What about the rest?

UK

Consider the mass of data Admiral is collecting on its UK customers: they offer Motor, Van, Household, Travel, and Pet insurance, as well as Personal Loans.

Each of these markets is of decent size. Pet is £2.2bn with 6 million policies and the average premium over £300; Travel is £1bn with over 10.5 million policies in force and average premium over £100; and Household is £6bn+ and the average market premium is finally approaching adequate levels at £400, after a decade of flat or negative growth.

At a similar penetration to Admiral’s UK motor business today, these lines could bring £1.5bn in written premiums, and Admiral mentioned in the 1H24 call how the RSA’s More Than deal has the potential to bring them close to double digit market share both in Household and Pet, a feat that took UK Motor 17 years to achieve.

Admiral knows their customers well, and they price to optimize profitability in the medium-term by being dynamic about rates. This contributes to a growing earnings power for Admiral’s UK insurance business: a multi-product customer has 10pp better retention than one with a single product and has a better loss-ratio expectation at renewal. Multi-product customers have been growing at a faster rate than the overall business growth as of 1H24.

UK results so far vindicate the Group CEO’s strategic decisions since taking over in 2021: thanks to continued investments in IT, Agile 2.0 and Multi-cover (and the group’s scale), Admiral was writing motor business at an expense ratio of 15.5% during 1H24. I don’t expect this ratio to be sustained, particularly if growth decelerates as expected, but it serves as a good demonstration of Admiral’s these investments paying off.

Household is now insuring 1.81 million customers, at 29% higher premiums than a year ago. The business seems to have reached an inflection point thanks to rate adequacy and accumulated reserves which are now being released, judging from the explosion in underwriting results: from £1m in total underwriting profit at a Combined Ratio of 99.6% in 2023 to £39m in 1H24 at a 76.5% Combined Ratio. This business is now a ~£80m PBT annualized contributor to the overall P&L and there is room to grow the current 9% market share. At 12x PBT, Household is a ~£1bn business for Admiral, 11% of the current Market Cap.

Pet and Travel are smaller markets, but can be very profitable. 2023 market Loss Ratios were 57% and 40% respectively. At a similar ~22% group Expense Ratio and similar market share to UK Motor these two could deliver £130-140m in PBT in the future, but it’s still too early for both.

Lastly, in the UK, there is Admiral Money, the personal lending operation, which has scaled fast but prudently. The loan book is currently over £1bn and PBT should be over £12m for the FY24. It turns out Admiral’s insurance customers are better Money customers, again proving the benefits of a multi-product offering. Admiral Money is still scaling up, but already enjoys best-in-class 34% cost-income ratios.        

Across the Channel

The European operations puzzle investors. 1H24 was disappointing, with Spain and Italy losing customers and France growing only 2.3% vs. year-end after several years of high double digit growth. Importantly, premiums were higher in each market and the number of customers has increased at 9% CAGR in the last 5 years.

Spain remains challenged, as anyone following Linea Directa can tell, and Admiral has been exploring and investing in new distribution channels, which are not yet mature and keep the business approaching but not topping break-even consistently.

Italy suffered a bigger than expected setback in June when the Milan Court increased Italian Bodily Injury settlement reference values by 16%, leading to reserve increases and a £12m hit to profits.

Competition in Italy has been fierce for years (average premiums have declined at negative 3% CAGR since 2011) particularly in the direct channel, where Prima Azzicurazzioni – and MGA backed by BlackStone, Goldman Sachs and SwissR – growing via aggressive pricing, has reached 3.5 million customers - 9% market share of vehicles insured – in about 7 years.

Ideally, 2^nd order effects of the Milan Table may resemble those of the 2016 Ogden Rate changes in the UK, where market participants were forced to increase reserves and later raise premiums meaningfully the following year. 2017 was a (very) profitable underwriting year for Admiral’s UK Motor (already a 34%-margin year). In a similar scenario, ConTe – which has been protecting margin at the expense of volume – could take advantage of the coming adjustment to resume growth.

Looking underneath these trends, ConTe is a success story: it has captured ca. 3% market share of the auto market, operates profitably (COR average of 88%, with no year above 100% between 2019-2023) and has done so despite having an average premium 11% lower in 2023 vs. 2019, and average market claim costs 10% higher. I want to see what this business can do under an adequate rate environment: only a decade ago, average market premiums were €498/policy and ConTe’s current scale means they spend €33/policy on average today. It could be a very profitable business!  

Importantly, ConTe is already a strong brand in Italian motor insurance, the www.conte.it domain is a top 6 amongst Auto Insurance industry domains measured by transactional intent (Analysis of the Motor Insurance Industry: The Best Domains and Strategies - SISTRIX). The business has been operating at scale for years and I am confident growth should resume soon. Premium trends in Italy are moving higher, with average prices up 6.7% YoY in August 2024, back to 2018 levels and seemingly accelerating upwards.

Source: ivcs686.pdf (ivass.it)

France is showing continued and profitable growth and management expressed satisfaction with the results so far, but it was surprising to see such a low level of policy growth.  

The company will be holding a second European Investor Day in 1H25 which may provide visibility into management plans and underlying value of the business. My hope that Italy would get separate disclosure as profitability inflected has not yet materialized. We’ll see.

In terms of valuation, a few reference points:

• Liberty Seguros was sold to Generali in late 2023 at an implied 2x Gross Written Premiums.
• Prima Assecurazzioni was seeking to sell a 10% stake in the business at an implied €1bn valuation during the 2H23, or ca. €385/policy
• Linea Directa currently trades at around €350/policy. A similar valuation implies €650m for Admiral’s European operations, but there are important differences: the growth prospects are much better for Admiral, particularly in France and Italy; and French and Italian customers are more profitable, so they are worth more. I’m positive that a standalone European business would command a higher valuation in the public markets.
• I estimate European excess reserves of ca. €42m in 2023. These have been accumulating in the past three years, from a deficit of €114m in 2020, which indicates European operations are generating decent capital, with reserves eventually released through the P&L. In 2023, Spain had a 102% COR, Italy 88% and France 89%. Management has proved they can deliver profits in Europe, but would investors support a more aggressive growth strategy?

Admiral’s European premiums are annualizing £666m and there were 1.87m customers as of June 2024. A valuation similar to those mentioned for comparable businesses implies they are worth between £0.6 and £1.3bn, or 7% to 15% of the current market cap. This is a wide range, but keep in mind that these are everything but homogenous markets, with LTVs, distribution channels and growth opportunities unique to each.

US

Finally, there’s Elephant, the US operation. There’s not much to say about it. It may one day make for a good business case study and surely Admiral has learned a lot from the experience (I hope!). The business is up for sale, currently in rundown mode and losing customers fast as they reprice premiums aggressively. Perhaps a buyer could value the NOLs, or someone may be willing to inject capital via a JV. I no longer assign value to it but would be happy to be surprised with any outcome above zero.

What about risk?

Investors can sleep well knowing management will always choose to err on the side of caution. Surprisingly, this is one reason why the US opportunity did not bear fruit, why the European operations are not yet meaningful contributors to the bottom line, or why the board has never taken advantage of the stock price volatility to repurchase shares, despite having shareholder approval since their IPO.

In terms of other risks, cheaper capital and appetite for irrational growth by competitors remain top of the list.

These can manifest in numerous ways. For instance, in the UK, the government will publish the new Ogden rate (the discount rate used to estimate the NPV of lump-sum payments for large bodily injury claims involving loss of earnings and healthcare costs) in January 2025.

Since 2001 it had been set at 2.5%, but was revised down in 2017 to -0.75% in England and Wales and later increased to -0.25% in 2019. Insurers had to put up reserves by about £1.4bn with a direct hit to profits and reinsurance costs went up immediately, resulting in higher premiums. Admiral’s relative advantage kicked in and they took the dislocation in the market as an opportunity to grow: between 2016 (when the rate went into review) and 2018, Admiral added over 1 million customers in UK motor, 9% CAGR, and grew premiums at 11% CAGR.

Fast forward to today, with higher interest rates, the government has launched a review of the rate. Scotland and Northern Ireland increased theirs at the end of September, from -0.75% and -1.5% respectively to 0.5% in both countries.  Interpolating from Admiral’s sensitivity disclosures, a 100bps positive move would have a £91m benefit to earnings after tax and reinsurance costs. This is a nice one-off indeed, but competitors’ balance sheets would also see an immediate capital benefit, and reinsurance costs could fall, making it cheaper to grow, reigniting competition, lowering premiums. PWC estimates that premiums may fall by up to 3% as the Ogden rate moves to positive territory.

Putting it all together

Admiral’s dividend yield today is ca. 4%, below its historical average. Still, since 2020, Admiral has paid £2.1bn to investors, 25% of the current market cap, for a ~6.25% annualized yield. Special dividends should get bigger in coming years.

Source: Company, Bloomberg

What you get

UK Motor £10.75bn + Household £1bn + Europe £0.7bn = £12.bn, equivalent to £40/share, 45% above the current price, and the 4% dividend yield (and perhaps some value out of the US, and Admiral Money, which I have not provided an estimate for here, and the Pet and Travel lines as they grow)

I would buy Admiral at £28/share today.

Catalyst

FY24 Earnings. 

European CMD in 2025

Time