CA - Intact Financial: High Catastrophe Losses Result In Weak Earnings

2023-11-10 10:30:00 ET

Summary

• Intact Financial is the largest provider of P&C insurance in Canada and is expanding its operations in the UK through an acquisition.
• The company reported stable financial results in the third quarter, with a strong net investment return.
• The preferred dividend coverage ratio and asset coverage ratio for Intact Financial are both healthy.

Introduction

Intact Financial Corporation ( IFCZF ) ( IFC:CA) is the largest provider of P&C insurance in Canada and also describes itself as a leading specialty lines insurer with international expertise. Overseas, in the UK and Ireland, it is a large player in the personal and commercial lines and the recent acquisition of the commercial lines business from Direct Line Insurance Group plc ( DIISF ) ( DIISY ) will further expand its operations in the UK. This transaction only closed in October and we will only see the impact and the contribution from this acquisition in the next quarterly update.

Stable (underlying) results in the third quarter

Before having a closer look at the preferred shares, I would first like to establish how strong the financial results are to ensure the preferred dividends are still covered.

The company reported a total result from its insurance division of C$437M and this was negatively impacted by the C$35M net expense from reinsurance contracts, resulting in an 'insurance service result' of C$402M. There also still was a net negative impact from the 'insurance financial result' of a negative C$149M and one of the footnotes to the financial results (see below) discusses where that C$149M negative impact comes from. These are mainly technical corrections and as you can see below, there was a C$260M hit from unwinding the discount metrics on insurance contracts. There also was a C$57M loss related to FX changes . On the other hand, there was a C$62M net reinsurance finance income where the changes in discount rates added a net amount of C$48M.

As you can see in the image above, this results in a total impact of the reinsurance finance expense of a negative C$149M compared to a positive contribution of C$35M in the third quarter of last year.

Despite the negative impact of this 'technical result', the company's net financial results remained relatively strong, mainly thanks to the strong net investment return of C$212M generated during the third quarter. While this was not substantially higher than in the first few quarters of the year, there is a very meaningful difference compared to the third quarter of last year.

Combining all elements, the insurance company reported a pre-tax income of C$184M resulting in a net income of C$163M. That's relatively low and this is mainly due to the elevated catastrophe losses during the third quarter as those CAT losses exceeded C$600M.

Surprisingly, the company's income statement does not show the impact of the preferred shares, but the EPS of C$0.83 does take those preferred dividends into account. As you can see in the image below, the company needed approximately C$17M to cover the preferred dividends which resulted in a net income attributable to the common shareholders of Intact Financial of C$146M, which is where the C$0.83 EPS is coming from.

This immediately covers one important aspect of what I'm looking for when I'm investing in preferred shares and that's the preferred dividend coverage ratio. And in the third quarter, despite the technical losses in the insurance division's financial segment, the company still only needed just over 10% of the earnings to cover the preferred dividend. And looking at the 9M 2023 results, Intact Financial needed just over 7% of its earnings to cover the preferred dividends, and that's a pretty comfortable coverage ratio.

As of the end of the third quarter, the company's book value was approximately C$77 per share, a small increase compared to the end of the second quarter. The BVPS actually increased due to the decision of Intact to issue new shares to fund an acquisition. The company announced and has since closed the purchase of the Commercial Lines business from Direct Line Insurance and it will be interesting to see the impact of the acquisition on the book value and of course the earnings profile.

Intact Financial has a bunch of preferred shares outstanding and there is a healthy mix of preferred shares that have a resettable preferred dividend rate that is locked in for a 5-year period and fixed rate preferred shares. The Series 5 has a fixed rate for life. In that case, it is a C$1.30 annualized preferred dividend which means the preferred dividend yield is currently just over 6.5%.

I have already established the preferred dividend coverage ratio but I obviously also like to check the asset coverage ratio. As you can see below, the balance sheet contained approximately C$15.4B in equity attributable to the shareholders of Intact, and about C$1.62B was related to preferred shares and other equity. This means there is almost C$14B in equity ranked junior to the preferred equity (and similar instruments) and that is a pretty healthy coverage level.

Investment thesis

Based on the Q3 and YTD results, Intact Financial does not appear to be too impressive at the current share price of in excess of C$200/share, especially as this also represents a triple-digit premium to the book value. However, the company is the leader in the Canadian P&C insurance market and the Q3 earnings were pretty disappointing due to elevated CAT losses.

As you can see in the image above, those CAT losses were C$373M higher in the third quarter of this year compared to the same quarter last year, and on a 9M basis, there was a C$475M increase in CAT losses. This was mainly caused by hailstorms and thunderstorms throughout Ontario while about a third of the CAT losses were related to the wildfire issues in Western Canada. And although the combination of all these events had a severe negative impact on the Q3 financials, none of the events reached the threshold to activate the reinsurance contracts so there was some bad luck involved as well.

And that's why I'm fine with cutting the company some slack as the underlying results of the company remain strong. That being said, at this point, I'm more interested in Intact Financial's common shares as I like the dividend and asset coverage ratios. And while the preferred dividend yield definitely isn't the highest on the street, the risk/reward ratio appears to be pretty good. I have not decided yet if I'd prefer a 5-year floater or a fixed rate preferred share and perhaps I should consider a combination of both.

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