SSREY - Swiss Re: 6.5% Yield And Cheap Valuation

2023-09-27 00:50:44 ET

Summary

• Swiss Re reports improved financial performance in H1 2023, supporting the sustainability of its dividend.
• Earnings analysis shows improved operating performance, higher net premiums written, and increased investment income.
• Swiss Re expects to report a net income above $3 billion for the full year and maintain strong earnings growth in the coming years.

Swiss Re ( SSREY ) has reported a much improved financial performance in the first half of 2023, being a strong support for the sustainability of its dividend over the long term.

As I’ve covered in previous articles , Swiss Re is an attractive income play within the global reinsurance market, due to a high-dividend yield that is supported by the company’s strong fundamentals and capital position. Since my first article on Swiss Re, almost one year ago, its total return is close to 50%, clearly outperforming the market during the same period.

Swiss Re has reported some weeks ago its first-half 2023 financial performance, thus in this article, I review its most recent earnings and update its investment case to see if it remains an interesting income pick or not after its strong share price performance over the past year.

Earnings Analysis

The reinsurance market has been on an uptrend regarding pricing, especially in the Property & Casualty (P&C) segment, due to several alternative players leaving the market after funding conditions turning much tougher during 2022, as interest rates increased across developed countries.

While this has been a positive backdrop for larger reinsurance companies, like Swiss Re or Hannover Ruck RE ( HVRRY ), which I’ve covered recently , the company’s financial performance during last year was affected by several issues, including high inflation, COVID-19 claims in its life segment, and higher catastrophe losses than expected, leading to relatively subdued earnings in 2022.

However, Swiss Re’s operating performance has improved in recent quarters, as higher top-line and lower expenses had a positive impact on its bottom line. Indeed, Swiss Re’s net income increased to $1.44 billion in H1 2023 , a very significant increase compared to the same period of last year, as shown in the next graph.

Its net premiums written increased by 4.4% YoY in the first half of the year, or 6.6% at constant exchange rates, supported by improved pricing in the industry at recent insurance policy renewals. Improved pricing led to better operating margins and lower nat cat losses were also positive for its underwriting trends, justifying a higher net income in H1 2023.

Its combined ratio improved across the P&C segment to 94.7% in the first half of the year, being on track to achieve a combined ratio below 95% for the full year. In its Life segment, its profitability returned to pre-pandemic levels, as U.S. excess mortality decreased to normal levels over the past couple of quarters, being key for a rebound of its net income in this segment ($393 million in H1 2023 vs. near zero in H1 2022). For the full year, Swiss Re expected life net income to be around $900 million, being a major improvement compared to the previous year.

Another positive tailwind for Swiss Re’s net income was higher investment income in recent months, due to higher interest rates, which led to increasing recurring income yield. Its reinvestment yield was, on average, about 4.6% in Q2 2023, while its overall recurring income yield increased to 3.5% in the last quarter. Due to this effect, Swiss Re’s recurring income increased by some $420 million in H1 2023, compared to the same period of 2022, being another positive factor for higher earnings.

Overall, its total revenues amounted to $24.1 billion in H1 2023, an increase of 8.6% YoY, and its earnings were $5.00 per share (vs. $0.54 in H1 2022). Its return on equity ratio [ROE], a key measure of profitability within the insurance industry, was 22.8% in the first semester, a big improvement from only 1.6% in the first half of 2022. Despite its strong profitability and positive earnings, Swiss Re’s book value per share declined slightly to $43.67 (-0.6% compared to its 2022 year-end value), due to negative other comprehensive income due to lower bond prices as interest rates continued to increase.

For the full year, Swiss Re expected to report a net income above $3 billion, an expectation that is unchanged from its guidance provided at the beginning of the year, representing significant annual growth (its reported net income was only $472 million in 2022) and the highest net income level since 2016.

This is supported by higher investment income, improved pricing in the P&C segment, and lower claims costs, factors that had a great impact on the company’s earnings in the first half of the year, a trend that the company expects to maintain in the coming quarters.

The street seems to think this guidance to be achievable given that, according to analyst’s estimates , its net income is expected to be about $3.1 billion in 2023, leading to EPS of about $10.5 in the full year. In the following years, current expectations are for smoother growth, which seems sensible given that its net income was impacted by several external factors in 2022 and Swiss Re’s impressive earnings growth in 2023 is not much likely to be repeated in the coming years.

Indeed, its net income is expected to increase to some $3.9 billion by 2026, which means its net income is expected to increase at an annual growth rate of about 7%, from 2024-26.

This is positive support for a growing dividend in the near future, while in the recent past, its annual dividend has been unchanged as the company’s earnings have been under pressure. Indeed, its annual dividend related to 2022 earnings was $6.40 per share, which was flat compared to the previous year when considered in USD.

Investors should note that Swiss Re changed its dividend distribution policy from CHF to USD this year, thus its dividend has been unchanged since 2020 (related to 2019 earnings). Based on 2022 reported EPS of $1.63, its dividend was not covered by earnings, which could be a warning sign about potentially questionable dividend sustainability.

However, its earnings were affected over the past few years by the pandemic and other external factors, thus the company decided to maintain its dividend even though it was not covered by its earnings. This is clearly expected to change this year, given that its EPS estimated in 2023 is $10.54, thus its earnings drop in the past wasn’t justified by the company’s fundamentals.

Considering current dividend estimate for its annual dividend of $6.71 per share (related to 2023 earnings), this means its dividend payout ratio should be about 64%, which is an acceptable ratio for a stable and profitable company like Swiss Re. At its current share price, Swiss Re offers a forward dividend yield of about 6.5%, which is quite attractive to income investors.

Beyond earnings, its dividend is also supported by Swiss Re’s strong capital position, given that its Swiss Solvency Test [SST] ratio was 280% at the end of 2022. While the company did not update this ratio at half-year results, it said that it's well above its internal target range of 200-250%, thus it has an ‘excess capital’ position enabling it to distribute a large part of its earnings to shareholders, being a strong support for a sustainable dividend over the long term.

Conclusion

Swiss Re has reported a much improved financial performance in recent quarters, showing that weakness in recent years was clearly justified by cyclical factors. Its fundamentals remain quite good and its dividend payout ratio should return to a ‘normal’ level related to 2023 earnings, showing that its dividend is sustainable over the long term.

Regarding its valuation, despite its strong share price performance over the past year, Swiss Re is currently trading at only 8.8x forward earnings, trading at a discount to its own historical average of 10.5x over the past five years, remaining an interesting income pick within the insurance sector.

For further details see: