2023-11-02 13:05:27 ET
Summary
- Allianz's history of solid P&C underwriting profitability has continued into this period of higher inflation, while investment income is also getting a nice boost from the higher interest rate environment.
- The company has also made good long-term moves in its Life/Health segment, though Asset Management is a slight drag right now due to falling AUM.
- Allianz is well on track to exceed its 2024 operating profit target, with my 2024 EPS estimate implying double-digit upside to fair value.
These are interesting times for German insurance giant Allianz ( OTCPK:ALIZY )( OTCPK:ALIZF ), with higher interest rates having finally appeared after a punishing spell at their prior ultra-low levels. With a split between P&C (~45% of group operating profit), Life/Health (~35%) and Asset Management (~20%), the current macro environment throws up some challenges for Allianz, but on the whole appears positive for the firm, with its shares significantly outperforming broad equity benchmarks over the past 12 months.
Allianz looks in good shape to meet the 2024 operating profit target set out by management in the company's last Capital Markets Day. Although up over 35% in the past year, at around 9x my forward-year EPS estimate the current valuation doesn't look too stretched to me, and I open on the stock with a Buy rating.
P&C Underwriting Profitability Holding Up Very Well
Allianz's P&C segment skews heavily to mature developed markets such as Germany (~22% of 1H 2023 segment operating profit), France (8%) and Italy (8%). While that means it isn't much of a growth engine for the company, with segmental operating profit up at a circa 2% CAGR between 2016 and 2022 (fig 1), it is nonetheless one of the better P&C businesses in its peer group.
Allianz P&C Annual Operating Profit
P&C profits come from two main sources. The first is from retaining more in premiums than is paid out in claims-related costs and on operating expenses. The other is from investment income, which is obviously largely a function of interest rates. In terms of the former, claims-related costs are captured by the loss ratio, while operating costs are captured by the expense ratio. Both are expressed as a portion of total premiums. Allianz's expense ratio has typically been at the better-end of its peer group, averaging a shade under 27.5% over the last five full fiscal years. That is better than the other European insurers with P&C businesses I have covered this year, with those being Zurich ( OTCQX:ZURVY )( OTCQX:ZFSVF ), Aviva ( OTCPK:AVVIY ) and Generali ( OTCPK:ARZGY )( OTCPK:ARZGF ). The loss ratio has also been solid, averaging around 67% over the past five years.
As a result, the company's overall underwriting profitability has been strong. It has averaged around 94% over the past decade, being profitable (i.e. below 100%) in every year (fig 2). Even in 2020, the company's worst recent year for underwriting profitability, it was below 96.5%, which is still pretty good.
Allianz P&C Combined Ratio
In terms of investment income, Allianz holds around €85 billion in fixed income securities in the P&C segment that it can currently reinvest at yields north of 4.5% (fig 3). Higher interest rates will therefore be a nice tailwind for overall segment income. While there has been concern that the impact of inflation on claims costs will be a headwind for P&C underwriting profitability, Allianz appears to be managing the environment very well. The loss ratio in the first half of the year was 67.2%, about in line with its 2021-2022 level.
Making Sensible Moves In Life/Health
Generally speaking I have not been a great fan of the Life/Health ("L/H") business. The main reason I say that is because this segment is essentially a mix of protection and savings products, and the savings business is very sensitive to macro factors like interest rates and equity market levels. In core European markets like Germany, popular savings products come with minimum guarantees attached. That doesn't pose an issue when rates stay at 'normal' levels, as life insurers could earn a reasonable spread, but when interest rates plunge and remain very low, like they did post-2009, then they can become a millstone around providers' necks as their assets typically mature faster than their liabilities. That means they were having to reinvest their assets at ever lower yields while still being on the hook for 3%-plus minimum guarantees.
This wasn't an Allianz-specific problem as such, but the company was at a particular disadvantage because its L/H segment skews heavily to markets in which this type of product was very popular. In response, the company has done a number of things to mitigate this, including shifting the business mix toward higher-margin protection products and savings products with less generous (or zero) guarantees. The traditional Savings & Annuities line only accounted for around 7% of new L/H sales in Q2 versus around 19% of sales in the same period five years ago. Life operating profit also looks to have a better balance these days (fig 4), though the Savings & Annuities business should still get a nice boost from higher interest rates.
Asset Management Lagging But Overall Outlook Attractive
Where Allianz is seeing some softer results right now is in its Asset Management ("AM") segment. Third-party assets under management totaled around €1.6 trillion at the end of H1 and skew around 75% to fixed income due to the company's ownership of PIMCO (~80% of third-party AUM). Higher bond yields have obviously had the inverse effect on AUM over the past year or so, and that has driven a double-digit year-on-year decline in fees and operating profit (fig 5). On the plus side, third party net flows have tentatively turned positive again after a period of outflows. That means there should be slightly less pressure on debt/equity valuations in terms of AUM levels.
While AM is a slight drag on Allianz's overall business right now, it isn't enough to offset gains made in the insurance business, particularly in P&C, which as per above is doing very well. The company is targeting over €14.5 billion in operating profit in FY2024, split between P&C (~€6.6 billion), L/H (~€5.3 billion), AM (~€3.7 billion) before around €800 million for the corporate center. AM is currently below target, L/H is on track, while P&C is already well ahead (fig 6).
Allianz already posted €7.5 billion in operating profit in H1 2023, so it is currently tracking for over €15 billion in FY24 operating profit. My estimate is closer to €15.5 billion - comfortably ahead of its €14.5 billion goal. That should map to core net income and EPS of around €10 billion and over €25 per share, respectively, or around $2.68 per ADSs (ticker: 'ALIZY').
Now, H1 net income equated to a return on equity of just under 17%. I think that should be good for a multiple of around 1.7x book value, implying a P/E of around 10.2x. That would get us to a forward-year price target of around $27.25 per ADS, while I expect an additional $1.28 in dividend cash as Allianz targets an approximate 50% payout ratio of core net income. Combined, that implies a total return of almost 20% over the next year or so from the current quote. For Allianz to be fair value right now at a 9% hurdle rate, the ADSs would have to trade for around $25.90, implying around 10% undervaluation at the moment. Buy.
For further details see:
Allianz: Strong P&C Performance Puts It Ahead Of Targets