ZFSVF - Zurich: Best ROE And Safest Balance Sheet Buy More

2023-08-11 12:51:14 ET

Summary

• Zurich Insurance Group delivered strong H1 financial results, achieving the best ROE and the highest operating profit.
• Key highlights include higher reinvestment yield and solid Solvency II ratio.
• 2023 guidance is confirmed, and so is our buy rating.

We are very pleased with Zurich Insurance Group Q2 financial release ( ZURVY ). The company delivered robust numbers in H1 with the highest operating profit and laid solid foundations to achieve the 2025 strategic plan.

Starting with the CEO's words, Mario Greco explained how the company " has made a strong start to the new financial cycle and achieved an ROE among the highest in the industry (Fig 1) while minimizing volatility and maintaining a strong balance sheet. " Here at the Lab, 2025 targets are ambitious but achievable. Following the Q1 analysis, we confirmed our buy rating target price of CHF 475 per share. Our buy rating was supported by 1) a higher forecast on P&C division growth combined with pricing action, 2) limited exposure in Russia/Ukraine and Credit Suisse AT1 and senior bonds, and 3) a solid Solvency ratio. Aside from the above company-related upside, we positively view the insurance sector here at the Lab. This is based on the new accounting standard called ' IFRS 17 ', the lower combined ratio and reinvestment yield backed by higher rates (and persistent inflation).

Source: Zurich Insurance Group Q2 results presentation - Fig 1

Mare Ongoing Upside

Before commenting on Zurich's H1 results, given our previous 10-year analysis of the company's primary financial ratio, today we are looking back at the following:

1. The combined ratio : as a reminder, the lower the combined ratio is, the more profitable the company is. Compared to last year, Zurich's percentage increased by 1.3% to 92.9%. This was due to a cautious approach to minimize volatility. Looking deeper into the analysis, if we exclude natural catastrophes, the commercial P&C was at 90.1% vs last year of 90.4%. The same better results were also performed in the Farmers Exchanges division, with an improvement of 1.1% to 94.1% (Fig 2);
2. The reinvestment yield reached 4.9% in the period, with an aggregate book yield of 3.4% (similar to AXA). A higher reinvestment yield means more profits, and looking at the investment results, we see that Zurich booked $765 in earnings related to the portfolio investments in the period (Fig 3);
3. The Solvency II ratio. The company delivered a solid balance of 263%, which remains well more than the regulatory requirements set at the?160% target level. Wall Street was unsurprised, and the company's ratio aligned with consensus (Fig 4).
4. Given the H1 results, we confirmed our next year's DPS projections for a dividend of CHF 26.5 from the CHF 24 dividend payment in 2023;
5. Here at the Lab, we believe that additional upside can be made thanks to pricing progression with commercial acceleration, especially in the US (commercial rates increased from 7% to 9%). If we look at Zurich's track record, we see a positive trajectory of 1% higher points quarterly in the P&C division. The additional upside might derive from a supportive quarterly performance from motors in Germany (Fig 5). This is backed by P&C growth , a higher risk-averse trend (after COVID-19), and a rebound in volumes of new motors/cars;
6. Lastly, as a reminder, we have always stated that the Farmers division was Zurich's Achilles' heel. With MetLife's acquisition, Farmers' operating profits were up by 8%, thanks to earned premiums growth. The division Surplus ratio development reached 30.2% (Fig 6); however, this was negatively impacted by Nat Cat development, and over the medium-term horizon, we expect this trend will reverse in the 32% ratio.

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Fig 6

Q2 results

The company's operating profit reached $3.7 billion and matched H1-2022 record levels. Zurich also recorded the highest ROE at 22.9%. EPS also grew by 8%, and the net profit attributable to shareholders increased to $2.5 billion. Cross-checking Wall Street estimates, the company beat operating profit consensus expectations by 5%. Looking at the divisional level, the beats were mainly driven by net investment results and higher investment income (one of Mare Evidence Lab's supportive points). Despite that, positive results were performed in the top-line thanks to pricing power, especially in the P&C business, with premiums up 17% on a like-for-like basis. Life operating profit also recorded a plus 11% to $0.9 billion, up 18% on a like-for-like basis, and (once again) the Farmers division grew by only 1% vs last year.

Source: Zurich Insurance Q2 press release

Conclusion, Valuation, and Risk Statement

Zurich has the safest and most profitable balance sheet among EU insurers. Looking at AXA and Allianz , they achieved a return of equity of 16.7% and 16.6%, respectively. While the leading German insurer reported a Solvency II ratio of 208%, and the French AXA reported a ratio of 235%. Following the H1 results, analysts should re-price the company. We are above Wall Street estimates (2024 EPS at €38.9 vs €36 per share). Consequently, continuing to value Zurich with a P/E of 12x, we confirmed our target price of CHF 475 per share . We also provided a Q2 update about AXA within our EU insurance coverage.

Concerning the downside risks, Zurich's target price might face 1) changes in the regulatory framework, 2) changes in taxation, 3) movements in exchanges rates, and 4) given the company's financial market exposure, Zurich might be affected by higher volatility and default risk (especially in the corporate bond). In addition, Zurich is also exposed to natural catastrophes.

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