BBSEY - BB Seguridade: Q3 Earnings A Balanced View On Bullish Trends

2023-11-08 22:43:38 ET

Summary

• BB Seguridade, a major Brazilian insurance company with ties to Banco do Brasil, posted impressive Q3 2023 results, including record-high net profit and a remarkable 91.5% return on equity.
• The company's unique partnership with Banco do Brasil's distribution channels and its profitable business model contribute to its strong performance and generous profit distribution to shareholders.
• Despite its solid performance, the potential impact of declining Brazilian interest rates (Selic) in 2024 prompts a rating shift from "strong buy" to "buy."
• BB Seguridade's diverse business lines, including insurance, pension, and capitalization, have shown positive growth, and the company aims for profit growth in 2024.
• The company's attractive dividend yield of over 11% and favorable valuation make it an appealing investment option, but future interest rate trends warrant caution.

BB Seguridade ( BBSEY ) is one of the largest insurance companies in Brazil, renowned for its association with its controller, Banco do Brasil ( BDORY ). The company specializes in marketing various insurance products, including insurance plans, private pension plans, dental care plans, and capitalization products.

In my initial article about the company, I emphasized my ultra-bullish outlook, primarily based on its exclusive partnership with Banco do Brasil's distribution channels. It is set to continue until 2033 and is subject to renewal.

The company's business model is exceptionally profitable, leveraging Banco do Brasil's physical infrastructure to distribute and sell its products. This unique arrangement results in an unusually high return on capital and, coupled with its minimal capital requirements, allows for the generous distribution of profits to shareholders.

The recent Q3 results once again demonstrated strength, aligning with my belief that BB Seguridade has the potential to offer a yield exceeding 10% for the current year, reaffirming my bullish stance.

However, considering that BB Seguridade isn't directly impacted by the challenging credit cycle and benefits from high interest rates, it is noteworthy that the Brazilian interest rate (Selic) is currently at 12.25% and is anticipated to see further cuts in 2024. This potential trend may become the primary factor affecting BB Seguridade's profits in the upcoming year. Therefore, I am revising my rating on the stock from "strong buy" to "buy."

BB Seguridade's Strong 3Q23 Results

BB Seguridade once again posted robust results in the third quarter of 2023, marked by its highest net profit in the company's history, reaching R$2.06 billion. This represents a significant increase of 11.7% quarter-over-quarter (QoQ) and 24.5% year-over-year (YoY), making it the highest in the company's history. The remarkable return on equity (ROE) of an astonishing 91.5% (compared to the historical average of 55.4% and the three-year average of 67.5%) is also a reason for optimism and likely positions BB Seguridade among the top performers globally.

The insurer's various business lines showed improved results, with particular strength in Brasilprev. The company benefited from the decrease in the IGP-M, an index responsible for adjusting specific pension plans. Interestingly, this factor negatively impacted BB Seguridade's performance in 2021, causing a significant drop in its stock price. This adjustment contributed approximately R$100 million to the net profit.

Additionally, the standout for the quarter was the expansion of the operating results. All business lines exhibited growth, including the business insurance segment, where the company holds a smaller market share.

Furthermore, in the first nine months of 2023, the non-interest operating results exceeded the growth guidance by 2.2 percentage points, achieving a growth rate of 19.2%. This growth result is critical to my thesis, indicating that BB Seguridade's stock performance is closely tied to the company's profit growth.

Brasilseg

The insurance unit recorded a net profit of R$1.05 billion, demonstrating substantial QoQ growth of 8.5% and an impressive 23.5% growth compared to the previous year. This was mainly due to the positive impact of premium growth, which increased by 2.5% YoY and an impressive 15.6% compared to last year. The solid financial results were not adversely affected by the 20.2% YoY decline in the Selic interest rate.

Furthermore, the claims ratio remained attractive, standing at 37.1%, showing a decrease of 1.9 percentage points QoQ and a slight increase of 0.15 percentage points YoY.

On the downside, the administrative expenses ratio increased by 0.3 percentage points YoY, primarily due to rising other operating expenses. Moreover, while the growth in premiums written was 8.2% compared to the previous year, it represented a significant recovery from the prior quarter (2Q23).

Nonetheless, this performance led to an accumulated total for the nine months of 2023 (9M23) reaching 12.4%, falling within the range established by the guidance (10% to 15%). Nevertheless, this rate indicates a slight deterioration compared to previous quarters, which had achieved accumulated performance figures above the provided guidance.

Brasilprev

The pension unit reported a net profit of R$528 million, marking a substantial QoQ increase of 17.5% and a remarkable 82.2% growth compared to the previous year. This positive performance was primarily attributed to a financial result of R$297 million, which expanded by 32.7% YoY and reversed a negative result of R$35 million in the third quarter of 2022. The line benefitted significantly from the deflation of the IGP-M, which led to a reduction in the cost of liabilities associated with traditional plans.

Furthermore, net funding in the quarter was robust, reaching R$5.1 billion, reflecting a substantial YoY increase of 187.8%. For the first nine months of 2023 (9M23), net funding reached R$7.3 billion, showing an impressive YoY growth of 611.9%.

On a less favorable note, the average annualized management fee contracted by 0.05 percentage points YoY due to a higher flow of investments directed towards more conservative products.

Brasilcap

The capitalization unit reported a net profit of R$73 million, showing improvement with a notable increase of 14.9% QoQ and a significant 94.3% growth compared to the previous year. This positive performance was primarily driven by a financial result of R$124 million, marking a 12% QoQ increase and an impressive 99% YoY growth.

Revenue from capitalization bonds experienced modest growth, increasing by just 0.6% YoY and 2.0% compared to the previous year, reaching R$1.65 billion. This growth can be attributed to an increased number of single-payment bonds sold.

On the less favorable side, net revenue from securities decreased by 2.9% YoY and 4.9% compared to the previous year, primarily due to higher participation of single-payment securities with shorter maturities of 12 and 24 months.

BB Corretora

The brokerage unit reported a net profit of R$791 million, showing more modest growth with an increase of 11.9% QoQ and a 5.4% growth compared to the previous year. This growth was primarily driven by brokerage revenues, which increased by 8.6% YoY and 3.5% compared to last year. These revenues were boosted by commercial solid performance and the recognition of deferred insurance and pension commissions.

On the less favorable side, the operating margin contracted by 0.2 percentage points YoY, primarily due to higher sponsorship expenses, incentivized donations, and the establishing of provisions for civil contingencies. Additionally, a negative impact of 1.6% YoY on brokerage revenues from the capitalization unit is attributed to the concentration on short-term single-payment bonds, which offer lower commissions than longer-term bonds.

What’s next?

As discussed in the previous article covering Q2 earnings, 2023 has been characterized by strong operating performance, bolstered by a robust financial outcome driven by the high-interest rates in Brazil (Selic), which exceeded 13% in Q2 and currently stands at 12.25% for Q4 and the foreseeable future.

Despite the likelihood of a reduction in the Selic rate for 2024, there are signs that interest rates will remain relatively high, which should help offset the expected decline in financial results. The Brazilian Central Bank has set a target Selic rate of 9.25% for 2024 and 8.5% for 2025.

In 2024, BB Seguridade's executives anticipate that some positive operating performance will continue. During the conference, the company's management emphasized its commitment to achieving profit growth in 2024, specifically focusing on the promising areas of credit life, agriculture, and life insurance. Consequently, I foresee a clear path to another year of profit growth for the company in 2024. Estimates suggest a return on equity ((ROE)) growth of at least 15%, which remains above the 24% average growth over the past five years.

Dividends: The Core of the Bull Thesis

With the strong Q3 results, I anticipate a higher dividend, which is expected to be announced in March next year alongside the release of 4Q23 results.

Despite operating in a mature market, BB Seguridade has expanded its insurance base significantly by investing in technology to enhance the customer experience. I expect a net profit of R$7.2 billion this year, which may fall slightly below the guidance of R$7.5 billion. BB Seguridade has indicated its commitment to maintaining its shareholder return policy, which involves paying a dividend ranging from 80% to 90% of profits while implementing a share buyback program.

Considering the company's more conservative payout ratio of 49% and its semi-annual dividend distribution frequency, I predict an annual dividend per share of $0.72 this year, resulting in a yield of 11%. Factoring in a return on investment ((ROI)) of 9%, which reflects BB Seguridade's average yield over the last five years, I estimate a target price of $7.99 per share. This would represent more than a 21% upside from the current share price.

In my projections, the company is trading at a price/earnings (P/E) ratio of 9x for 2023 and 8.7x for 2024, below the sector average, which I find attractive given the resilience of its business model and the substantial returns expected to be distributed. It's important to note that as BB Seguridade has Banco do Brasil as its controlling shareholder, the company's valuation incorporates a discount for political risk, justifying the somewhat discounted overall valuation.

The Bottom Line

BB Seguridade's Q3 results again demonstrated strong profitability, meeting but without significant surprises. The company continues to benefit from positive dynamics in its key divisions, particularly insurance and pension, which are expected to be sustained for the remainder of the year.

In the bigger picture, BB Seguridade appears well-positioned to meet consensus expectations of achieving a net income of R$7.5 billion for the year. Based on my forecasts, this should imply a multiple of 8x forward price-to-earnings (P/E) for 2024 and an appealing dividend yield of over 11%.

Considering the ongoing trend of lower interest rates in Brazil (though it is expected to remain relatively high for the next few years), which might hurt results in 2024 compared to the current situation, I am revising my position from "strong buy" to "buy." This adjustment acknowledges the company's robust dividend distribution, expected to continue throughout 2024.

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