ARZGF - Generali: A Speculative Buy (Rating Upgrade)

2023-12-16 04:32:58 ET

Summary

• Assicurazioni Generali has solid fundamentals and excess capital, potentially leading to enhanced shareholder remuneration in the short term.
• Ageas SA/NV has outperformed Generali since the recommendation, up 13.5% vs. less than 4% for Generali.
• Generali's recent earnings report showed positive performance in gross written premiums and operating profit, with a strong capital position.

Assicurazioni Generali ( ARZGF ) has solid fundamentals and an excess capital position, a backdrop that may lead to an enhanced shareholder remuneration policy in the short term.

As I’ve covered in a previous article , while Generali has an interesting dividend yield, its premium valuation was not warranted given that Generali’s growth prospects aren’t impressive, and I have recommended ageas SA/NV ( AGESY ) as a better income alternative.

As shown in the next graph, this recommendation to play out well, given that ageas SA/NV has outperformed Generali since then, up by 13.5% vs. less than 4% for Generali.

In this article, I review Generali’s most recent earnings and update its investment case, to see if it’s currently a more interesting income option within the European insurance sector or not.

Earnings Analysis

Generali has reported some weeks ago its financial results for the first nine months of 2023 (9M 2023), which were ahead of expectations, especially regarding its bottom-line.

In 9M 2023, Generali’s gross written premiums increased by 4.7% YoY to €60.5 billion, supported by the positive momentum in the Property & Casualty (P&C) segment. Indeed, P&C premiums increased by more than 11% compared to the same period of 2022, while the life segment reported a more modest performance.

Given that Generali’s business is more geared to the Life insurance segment, this can be considered a good operating performance, given that rising interest rates makes other investment alternatives more attractive to customers, such as time deposits from the banking sector, putting some pressure on net inflows to life insurance products.

Its consolidated operating profit increased to €5.1 billion in 9M 2023, an increase of 16% YoY, justified by strong earnings from the P&C segment due to lower weather costs than in 2022. This segment increased its operating result by 50% YoY to €2.15 billion, while on the other hand the life segment reported an operating income of nearly €2.8 billion (-1.1% YoY), and the asset management business had an operating income of €728 million (+3.8% YoY).

Its strong results from the P&C segment are justified both by better pricing, as the company raised prices across several insurance lines in the last few quarters, to reflect inflationary pressures and higher claims costs in the recent past. Indeed, Generali increased pricing in motor and other personal lines, leading to average premiums rising by 6.9% YoY in 9M 2023. Another positive factor for its operating result was also contained claims costs, which led to a combined ratio of 94.3% in 9M 2023, compared to more than 97% in the previous year.

Regarding its investment income, it was also a boost to its earnings from higher bond yields, plus it also took some profits from its equities exposure benefiting from the strong performance of stocks in the year.

Due to this positive operating momentum, its adjusted net result in the first nine months of 2023 increased to €2.9 billion, up by close to 30% YoY. Its solvency ratio was 224% at the end of last September, maintaining a very strong capitalization level within the European insurance sector.

These positive results don’t include the company’s recent agreements to buy Liberty Mutual insurance operations in Portugal, Spain, Ireland, and Northern Ireland, plus its pending acquisition of Conning Holdings in the asset management unit. These two deals were announced some months ago and are expected to be completed during 2024, thus they will increase Generali’s exposure to the P&C and asset management segments, as part of its strategy to diversify its business and reduce its reliance on life insurance.

Nevertheless, life insurance is expected to remain the company’s most important segment over the next few years, unless Generali perform some relatively large acquisition in other business units. While I don’t expect this to happen, Generali’s strong capital position enables it to perform acquisitions and if the opportunity arises it may decide to grow its business in the P&C or asset management segments in a significant way through a potential acquisition.

Nevertheless, Generali will perform an investor day at the end of next January, when it will update investors about its strategy for the next few years and provide new financial targets, probably for the period 2024-26. I don’t expect the company’s strategy to change much from its current one, focused mainly on organic growth, and to use its excess capital position to return capital to shareholders.

This is clearly positive for its dividend , which is likely to be the preferred way to distribute earnings and excess capital to shareholders in the coming years, while a share buyback program may also be announced. This expectation is supported by Generali’s capital ratio that is well above its peer’s average, which have Solvency ratios around 200%, plus the company’s good capital generation capacity.

This means that Generali does not need to retain much earnings going forward and can be therefore more aggressive regarding its capital return policy in the coming years.

However, this doesn’t seem to be currently expected by the street, given that its dividend is expected to grow from €1.16 per share related to 2022 earnings, to nearly €1.40 per share by 2026 (related to 2025 earnings).

This represents an annual growth rate of only 6.2% over the next three years, which seems to be quite conservative, even though is close to Generali’s historical growth rate over the past three years. Nevertheless, its last annual dividend of €1.16 per share represented an annual increase of 8.4%, which was a boost compared to the previous years when its dividend increased at an annual rate of 5.2% and 5.9%, respectively.

Given that current dividend estimates is for Generali to grow its dividend to €1.25 per share related to 2023 earnings, its dividend is expected to increase by 7.8% YoY, thus it doesn’t make much sense to reduce its annual growth rate in the following years. Therefore, Generali clearly seems to have some room to beat current sell-side expectations regarding its dividend in the coming years, which would be a positive catalyst for a higher share price in the short term.

Its dividend policy is likely to be updated at its upcoming investor day, being an important event for Generali’s investors to watch, as it could potentially be well received by the market if the company decides to become more aggressive regarding its shareholder remuneration policy.

Conclusion

While Generali has sound fundamentals, this was reflected in its valuation some months ago and for that reason my recommendation was to buy ageas SA/NV instead of Generali. While I still prefer the Belgian company over the long term, I think that taking a speculative position on Generali makes sense because the company will have an important event next month that could move its share price.

Given that Generali has a solid capital position, it may decide to be more aggressive regarding capital returns, making it an interesting speculative play in the short term.

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