Description

Investment Thesis

If you like to shop for stocks where sentiment/headlines are negative, allow me to introduce you to Allianz, the parent company of asset manager PIMCO. Unless you’ve been living under a rock, you’re well aware of Bill Gross’s abrupt departure from PIMCO a few weeks ago. This resulted in the stock declining by over 10% (vs. 4.5% for the S&P 500) since the announcement, equating to an $8.3 billion loss in market value—implying Mr. Gross is one valuable man! [Note: Janus, where Gross joined, has had a market cap lift of ~$0.4B].

• Allianz is not only cheap on an absolute basis, trading at an undemanding 8.8x 2014E EPS and sporting a 4.3% dividend yield, but is valued at a 15%-20% discount to pure play Property & Casualty/Life & Health insurance comps with similar return on tangible equity compared to Allianz’s insurance businesses.
  • However, when factoring in Allianz generates 20% of its earnings from asset management, the discount relative to the comps (given asset management firms trade at much higher multiples than P&C/L&H companies) is ~25%. As a result, including dividends there is ~50% upside in a base case over 3 years.
  • There is no justifiable reason why Allianz’s insurance businesses should be valued at a discount to pure play insurance comps. Its return on tangible equity is in-line with the industry average. It has one of the strongest balance sheets in the industry with large excess capital reserves. Available capital is almost 2x that of required capital. S&P rates Allianz AA, which is the highest in the P&C/L&H insurance industry and better than its European counterparts, Zurich (AA-) and AXA (A+).
  • Its market position in its key businesses is enviable. It is #1 globally in property & casualty, top 5 globally for life and top 3 in the German health insurance market.
  • About 80% of its asset management business is comprised of PIMCO, a top 5 global asset manager (with $1.8 trillion AUM of which $1.4 trillion is 3^rdparty assets) and the preeminent fixed income manager in the world. More than 80% of its funds and assets under management have beaten their benchmarks on a 3 and 5 year basis while AllianzGI (~20% of Allianz’s AUM) has more than half of its assets outperforming over the past 3 years.
    • Negative headlines relating to Bill Gross has impacted PIMCO’s other PMs as well as outflows.
      • However, there are other very capable managers that represented 40%+ of PIMCO’s AUM (prior to Gross leaving) who largely have very good track records and will take over the Total Return Fund.
      • Summary: Using P&C/L&H insurance median comp multiples based on P/E and P/Tangible BV, Allianz’s insurance businesses alone are worth over €100 per share. Over the next 3 years, one will receive dividends of €17 per share. At €122, downside is very limited. One is practically getting its asset management businesses for free.

BUSINESS OVERVIEW (all numbers are pro forma based on a ~$100 billion estimate of future outflows due to Gross’s departure)

• Allianz has revenue of €100B and €10B of operating profit
• Op. profit break-down: ~45% P&C insurance/35% Life&Health Insurance/20% Asset Management
• Allianz has grown its operating profit at a 10-year CAGR of 5%+.
  • Allianz’s insurance businesses have grown op. profit at a 3%+ CAGR over the past decade.
    • At the same time, it has seen its pre-tax return on tangible equity for these businesses decline from an average of 29% from 2005-2008 to 20% from 2009-2013.
• However, its asset management businesses have grown op. profit at a mid-high teens CAGR over this time.
  • This growth compares very favorably to industry fixed income AUM increasing at a ~10% CAGR.

Property & Casualty (P&C): ~45% of op. profit

• Allianz is the largest P&C insurer globally with more than double the share of its next closest competitor.
• Business mix: 35% motor/15% property/17% accident/12% liability/21% other
• Auto insurance pricing in Europe, particularly within Germany, has been increasing. Competitors are being more disciplined.
• Allianz’s Liability business (12% of premiums) is the only long-tail business—an example would be insuring a pharmaceutical company for a new drug in the event it has harmful side effects it didn’t know about.
• Allianz is consistently around or below the median regarding its loss and combined ratio while its expense ratio has been consistently higher.
• Allianz has had a fairly consistent loss ratio in P&C over the past 10 years, averaging 67.7% and +/- 2.7%.
• After seeing an elevated loss ratio from 2008-2010, it implemented various initiatives at the end of 2010 to bring its claims ratio down. Per management:

“Now you see that our underwriting result from 2006 to 2011 had continuously decreased…largely driven by claims ratio. So therefore, end of 2010 we initiated…a claims initiative where we really tried to address all the elements which are important to be excellent in claims management. So starting at a faster notification.

We also have redesigned processes and structure with regard to claims. Again, we have a personal responsibility, again, when it comes to single claims. We have clear allocations of claims handling units towards brokers and also towards agents, which makes it much, much easier to respond to the needs of these distribution partners as we are handling that. We have introduced a new steering system in order to support everything we want to do on the claims side.

We have put out a central number which customers can call in any claim. Obviously, they still can continue to come through their agents, but we really push this number, as we can provide a better service, a faster service to our customers. And at the same time, we know that claims costs are lower if we are fast enough at the claim. And we can do proactive claims management, be that steering into body shop networks, be that steering into our repair network we have. We're one of the few companies having a repair network on the non-motor side in Germany. So this all is possible if we get really fast notification on the claim side.”   

• Its expense ratio in 2013 was worse than the industry average.
• It has initiatives in place to improve its expense ratio. In 2013 its P&C expense ratio was 28.4% compared to its target of 26.0%.
  • Holding everything else constant, if Allianz is able to achieve its goal, it would increase P&C op. profit by ~20% and total op. profit by ~10% compared to LTM.

• Additionally, it has various other initiatives to improve its P&C business. Per management:

“[One] initiative was our IT support of the broker. So our portal was considered…to be relatively poor, at least worse than what our competitors have been offering. So we also, thanks to a good support from IT, we were able to update that relatively quickly. We had some quick wins and are now in the process of continuously improving that broker platform towards the need of the different categories of the brokers. Fourth point and sixth point, in a way, were everything around operations in underwriting and claims. The feedback was that we did not really have allocated distinguished underwriters and claims people allocated to those brokers, especially the large ones, especially the ones which are professional in their respective lines of business. So we changed that and have now clear interfaces to those brokers, which also means, because broker's business obviously is a people business, that people know each other, again so they do not have to call into a call center when they have a claim but they have a physical contact point to get into our organization and then get all the services organized they need.
 
And last but not least, we're working on the business reporting system…We didn't really have a good overview on what profitability we have with each and every of the brokers along the lines of business, et cetera, so we're improving that. And that we also understand what is our share of wallet with regard to those brokers in order to be in a better position to negotiate with our partners when it comes to business development for the future years. So this is what we have been initiating in the broker channel.”

• Allianz had been losing share in motor insurance because its pricing segmentation was poor. It finally fixed it in 2012 and has been regaining share since. At the same time, it formed a joint venture with Volkswagen to offer insurance directly to consumers when they purchase/lease a VW vehicle. Per management:

“If you look at the total motor business in premiums, for the first time in 2012, we have been increasing the portfolio. Also on the number of contracts, we have been able to stop the erosion we had. So we have been flat and we're optimistic to turn that into positive turf moving forward. Now as we are looking into profitability, it's important to understand that we have put a new tariff behind that product. We have, as we have chosen [to] price these modules individually. We have introduced new factors, new relativities of the factors, new combinations. This led in some to a substantial improvement in the first-year loss ratios, as we always look after this business and follow the business on a cohort basis also here. So if we compare that to previous product implementations, then we're substantially ahead of what we have seen there.”

• Allianz has focused more on the lower cost direct-to-consumer distribution of auto insurance. As a result, it has seen growing policies and gross premium written in the DTC channel over the past few years.
• However, overall auto policies and gross premium written (GPW) have been flattish in part due to being disciplined on pricing. From 2010-2012, GPW increased 0.9% while contracts declined -0.4%.
• Allianz’s P&C business performed well in 2013 with operating profit up 14.2% YoY.

Per management: “The 2 percentage point improvement in combined ratio is very much linked to underlying loss ratio improvement. Actually, the expense ratio deteriorated by 50 base points, so it is all better underwriting results reflects our underwriting and pricing discipline and all the actions we have taken, and should lead us also in an even more exciting year 2014.”

• Allianz sells off some of its risk to reinsurers. In 2013 it ceded 8.6% of gross premiums written.
  • Pricing to sell off risk has been declining, which is good for Allianz. Pricing has been declining because alternative buyers (i.e. pension funds) have been coming into the market and therefore bidding pricing down.
  • The low interest rate environment is hurting its interest income. Its reinvestment yield is down 50 bps YoY despite increasing its duration from 4.5 years to 4.7 years.

Life & Health (L&H): ~35% of op. profit (93% Life/7% Health)

• Allianz is a top 5 life insurer globally and #1 in Germany. It offers various life insurance products.
• Germany, which makes up ~35% of Allianz’s life insurance profits, has seen op. profit growth since 2000 lag the growth of its GPW.
• Allianz has grown its premiums in Germany faster than the market since 2000.
• Allianz has had a high and increasing share in life insurance due to a great reputation as a rock solid company.
  • Its market share has increased because its excess capital allows it to invest more in longer duration bonds as well as some capital into equities and real estate to generate higher returns. This in turn allows it to offer better comparative rates to customers.
    • Currently, it offers 3.5%-4.0% returns in the German market vs. the ~2% risk free rate.
    • A majority of its life insurance business is sold through tied agents and brokers.
    • Allianz’s good reputation is well deserved due to the strength of its balance sheet and quality of its capital position.
    • Life insurance has been a growing industry over the past decade in part due to taking share from mutual funds.
    • With the trend in Germany of Insurance assets increasing as a % of the total, comparing it to other European countries that have a higher percentage, there appears to be further room for the industry to grow share.
    • Since its liabilities are fully covered for the next 20 years by the cash flows from its fixed income investments, this allows it to increase the duration of its new debt investments in order to maintain a good return on its portfolio. However, should interest rates rise, this would have a negative impact on its asset value and tangible book value.
    • Despite increasing the duration of its assets by one year, the reinvestment yield of its debt securities declined by 40 bps YoY.

Health Insurance (100% Germany): ~7% of L&H 2013 op. profit

• Comprehensive insurance is the statutory insurance that is offered by the government. However, people with more than €52.2k in income can opt out and buy private comprehensive insurance. This can be advantageous as premiums are lower in earlier years and also the service offering might be differentiated. Supplementary insurance would then cover additional riders such as dental insurance, private hospital rooms and long-term care, which are not that big of a cost factor compared to medical expenses.
• Allianz grew health insurance op. profit by 2.0% YoY in 2013.
• Allianz has a superior expense ratio in both its Life and Health businesses vs. its competitors.
• Allianz saw its L&H op. profit decline -8.0% YoY in 2013 due to an -8.7% decline in life insurance profitability.
• The life insurance profit decline can largely be explained by the German, Italian and Netherlands markets.
• Lower L&H op. profit in 2013 can largely be attributed to a lower investment margin due to lower interest rates.

Per management: “Value of new business was certainly disappointing in 2012, has recovered back to almost EUR 1 billion. The 2.1% new business margin should not be the end of the story. The last quarter was already at 2.6%. And when you go to recalculate the new business for the last 12 months with the interest rates of year end, then we would have shown already [a] 2.4% [margin]. And I give you this calculation more as a starting point for 2014, that actually a 2.5% new business margin.”

Balance Sheet Strength

Per management: “Our economic solvency will, when we move to Solvency II final calibration, will probably go down, let's say, around 30 points. So is this concerning? No, because whether you have a Solvency II ratio of 220%, or 180%, or 190%, that is really not making any difference because the target is 100% Solvency II ratio, and certainly, as a group, we want to keep a buffer above it that we can also stand a new renewed financial crisis far in the future or near in the future. So therefore, it's more announcement of a number change and not of a content change because we are still running under the Standard & Poor's model AA with a surplus margin, which actually expanded slightly during the year 2003 [ph], so our capital base is as strong as ever. And I would call our current position absolutely fit and proper for purpose in Solvency II and whatever else is coming.”

• Appears to have a lot of excess capital: €46.5B of available capital compared to €25.6B of required capital
  • But Solvency II calibration, once finalized, could change the amount of required capital.
    • Solvency 1 did not look at the difference between how premiums were invested.
    • Solvency 2 looks at the mark-to-market of liabilities and assets; and looks at the duration of assets.
    • Solvency 2 would require that 99.5% of value at risk is set aside so that only 1 out of 200 years would the insurer be insolvent.
    • What has been proposed thus far is that global equity investments would require a capital charge of 39% (less liquid equities could be up to 49%). A charge of 25% will be applied to real estate holdings while debt-related investments could be much cheaper at just 15% along with no capital charge for sovereign debt.
      • Allianz only has 8% of its assets invested in equities (6%) and real estate (2%) such that if/when Solvency II is passed (likely in 2015), it will still have a large amount of excess capital compared to required capital.

Asset Management: ~20% of Allianz op. profit

• PIMCO makes up over 80% of Allianz’s asset management business. PIMCO is a top 5 global asset manager and is the largest fixed income manager in the world with more than 80% of its funds outperforming on a 3 and 5 years basis.
• A majority of Allianz’s AUM is in fixed income.
• As a result, it’s important to look at fixed income’s market share of the asset management industry. Currently, bonds have a 22.2% share compared to the 23.3% average over the past 29 years. Should rates increase allowing bonds to offer more competitive returns compared to equities, fixed income share could increase into the low-30s as it was from 1985-1994 when the 10-year treasury yielded an average of 7.7% vs. less than 3% now. The time periods where bonds lost share of the industry was either during frothy markets such as the dot com bubble (flows into equities) or after bear markets (flows into money market funds).
• • While rising interest rates would hurt existing assets on a mark-to-market basis, it would likely spur share gains.
  • While 2013 saw op. profit up 7.0% YoY (+10.0% in constant currency), AUM ended the year down 4.4%, which will impact 2014 op. profit.
  • Of the 4.4% decline in AUM, net outflows represented just 17% of the decline in AUM whereas a strong Euro explained 83% of the decline.
  • Performance fees, which have benefitted 2012 and 2013 results, will be a headwind in 2014 given the tough comparisons.

  Per management: “Translating the fee into operating profit. Operating profit, 7% up. Could have been 10%, so we still count that the dollar helps us in the future. And it is very much volume- and margin-driven as the slide shows you here, where, on performance fees, you'll see already the first step to normalization. We are EUR 250 million lower than the year before, and this trend will continue also in 2014. Please remember that we had a couple of private funds mainly investing into subprime mortgages and really created fantastic returns for the investors, and also very decent performance fees for the fund managers. And we are currently building up a new generation of these funds, and I hope we can talk about it in the following quarters. But at the moment, we don't see any performance fees coming out of this.”

  • A majority of its AUM has outperformed its benchmarks on a 3 and 5 year basis.
  • Even with the poor 2013 performance, 84.4% of its mutual fund/ETF related AUM has outperformed their respective benchmarks on a 3-year basis while 82.0% has outperformed on a 5-year basis. The weighted average performance of its AUM on a 3 and 5 year basis put its funds in the top 35% and 34%, respectively.
  • Despite PIMCO’s solid outperformance on a 3 and 5 year basis, only 23.3% of its mutual fund/ETF related AUM has outperformed their respective benchmarks over the past 12 months. Its weighted average performance puts its funds in the bottom 31%. As a result, it has seen net outflows since June, 2013. This has been largely due to the underperformance of Bill Gross’ total return fund in 2013 (first down year since 1999). Excluding Gross managed funds, the weighted average performance of funds that represent 40% of PIMCO’s AUM were in the top 48% over the LTM. Additionally, there has been a great deal of negative press from the departure of PIMCO’s former CEO, El-Erian, announced at the end of January, 2014.
    • Over the LTM, PIMCO has seen net outflows of -11.4% of its AUM in its mutual funds and ETFs, which make up ~1/4 of its total AUM and ~1/3 of its 3^rdparty AUM. This compares relatively poorly to the fixed income industry, which has seen net outflows of -2.0% over the LTM. On top of that, PIMCO’s AUM (in $) have declined an additional -1.2% due to performance compared to the fixed income industry’s -0.2% decline.
      • However, over the past 2 months, funds not related to Gross have seen strong net inflows of over $1.5 billion on a mutual fund/ETF AUM base of $201.4B. Over the LTM, non-Gross related funds have seen net inflows of $0.7B, which compares favorably to the fixed income industry.

   

  Despite the continued net outflows in Q1’14, management remains upbeat about the future of its asset management businesses: “So on the Asset Management side, we do have a couple of product innovations, and they are already contributing to our third-party business. We've lined up a couple of things here. Allianz Global Investors. That's just been in the U.K. We've got a lot of praise for our infrastructure debt team there. The active ETFs from PIMCO are working great. We do have over EUR 20 billion now. So there's something in -- that happened on the Asset Management side that keeps me pretty optimistic.”

  Opportunities

  • IT center consolidation alone (see page 8) would save €400M annually, which would increase op. profit by 4%. Should it realize its goal of reducing its P&C expense ratio to 26.0% from 28.4% (including IT savings), all else being equal, total op. profit would increase by 11% compared to 2013.

  Per management: “In P&C in Germany, we still have some integration work to do in Turkey. Our merger in Benelux is working very well, but we have to finalize that. We've just started last month the Iberian platform in Brazil with good expectations. There are some more work to do in Allianz Worldwide Partners, where we are now integrating the hedge portfolio from Allianz France. We have started our IT center consolidation project. That gets us down to 6 instead of 140 today. That's obviously something that will run for, not only 2014, but we are targeting 2017 to be ready. The restructuring time and [indiscernible] obviously, we do make some good progress in China. We have a reinsurance program where we increased the sessions [ph] to Allianz with -- we have a higher volume than some negotiators or reinsurance partners. And we have some FTE-reduction programs that Dieter has alluded to.”

   “So it's EUR 10 billion +/- EUR 500 million. I think that is strong and confident. You know that we've always shied away a little bit from touching the EUR 10 billion. Now we have them. It's our midpoint. And yes, you are right, we expect major delivery in the P&C side, with hopefully some upside on the Life and on the Asset Management side. And if Dieter [in charge of Finance, Controlling, Risk] wants to make a big bonus, then he will drive corporate down.”

  Optionality

  • Higher Interest Rates: all else being equal, for every 100 bps increase in interest rates, pre-tax profit would increase by 13.9% vs. 2013.
  • Spin-off of asset management businesses, particularly PIMCO: This would unlock the value of this global franchise that is not being properly recognized. While management has never indicated its willingness to do this, it has said that there are no synergies with its insurance businesses other than to provide less volatility in its earnings. Also, ~80% of its AUM is 3^rd party assets. Were PIMCO to be spun out, it’s unlikely Allianz would materially change its allocation to PIMCO given its increasingly greater need to invest in fixed income per pending Solvency II requirements, which will make it more onerous to invest in equities and real estate.

  Capital Allocation

  • Allianz annually pays out 40% of its net income in dividends to shareholders.
  • Over the past few years, Allianz has made just €0.5B in acquisitions while investing €1.3B into real estate. At the same time, it has invested €2.1B in excess of D&A into its business for internal growth.

  Per management: “Now on the acquisition strategy you know that we are trying to prove to you that we keep rational and don't want to spend too much money on it, but do some smart stuff that helps us to gain scale and distribution power. We've done the insurance distribution agreement with HSBC for Continental Europe, very much in line with our Turkey strategy. And then we did the acquisition of Yapi Kredi, and we've entered into a European automotive partnership with Ford. It didn't cost us anything. And then we are, as you know, in exclusive negotiations with Unipol in Italy. So I think that's all very consistent with our communication."

  • Allianz’s insurance related ROE has been hurt by lower P&C profitability. Total and tangible equity in the business were at similar levels in 2013 vs. 2006. Insurance related revenue was up 8.9% over this time while insurance related pre-tax income was down -9.7%. While both its loss and expense ratios are up (combined ratio was +140 bps compared to 2006), lower interest rates have hurt as well. P&C interest income has declined from €4,096 to €3,048 over those 7 years, which helps explain a large part of the decline in ROE.

  Comps

  • Allianz is trading below its European counterparts (such as Axa, Generali and Zurich) on a P/E and P/NAV (NAV defined as Shareholders’ Equity – Goodwill) despite having an above average RoNAV.
  • Excluding asset management, Allianz’s return on tangible book value of ~12% is in-line with the largely pure play P&C/L&H global industry’s median return on tangible equity of ~12%.
  • Asset management businesses tend to trade at much higher earnings multiples (typically mid-teens or higher) than do insurance companies.

   

  Valuation/Potential Return

  • It makes the most sense to value Allianz on a sum-of-the-parts basis since insurance businesses are typically valued on a P/Tangible BV and/or P/E basis while asset management businesses, given their capital light nature, tend to be valued on multiples of earnings, EBITDA, revenue and/or AUM.
  • Even in a low case, including dividends, one should earn a high single digit IRR over the next 3 years. If Allianz’s businesses were ultimately valued at the median comp multiples, one could realize a 50%+ return over 3 years.
  • The value of its insurance businesses plus dividends received over the next 3 years shows there is little to no downside at the current valuation based on €122 stock price.

Catalyst