2023-04-17 05:43:46 ET
Summary
- Few investors have Hannover Re on their watchlist, even though it is one of the three largest reinsurers in the world.
- The Hannover Re stock is overvalued, but the hope of significantly rising profits in the coming years can justify the current high share price.
- Based on adjusted earnings per share of €18.54 expected for 2025, the P/E ratio is only 10.7 and thus far below the historical average.
- Based on the figures expected for 2025 and compared to the historical average, the stock has an upward potential of more than 37 percent.
Few investors have Hannover Ruck SE (HVRRY) on their watchlist, even though it is one of the three largest reinsurers in the world in terms of premiums. (For information: Gross premiums are the total costs of an insurance company and include all taxes and fees. Net premiums, on the other hand, represent only the pure insurance costs.) In addition, the Hannover Re stock has performed quite impressively over the past five years, generating a return of more than 40 percent (excluding dividends).
As a reinsurer, Hannover Re insures other insurance companies against insurance risks vis-à-vis their customers. As with ordinary insurance, the primary insurer (i.e., the insurance clients of a reinsurer) pays the reinsurer an insurance premium. For example, the primary insurer transfers the insurance risks of its flood insurance policies to a reinsurer such as Hannover Re. In return, Hannover Re receives an insurance premium based on the probability and size of the loss. Hannover Re, in turn, hedges against these risks on the capital market.
The heavy burden of major losses in the wake of climate change is not a red flag
In 2022, numerous major losses were caused by natural disasters such as hurricanes, forest fires, floods, and earthquakes. Such major losses significantly burden the insurance industry, as insurers have to pay for the costs. As climate change continues, the number of natural catastrophes is expected to increase, burdening the insurance industry. In some cases, premiums could become so high as to be unaffordable for policyholders , especially in coastal areas at risk of hurricanes or floods and in dry areas with frequent forest fires or droughts.
While the number of claims is increasing, the cost of major losses is also rising steadily. To cover major losses, reinsurers set up so-called catastrophe budgets to cover the expected losses. However, these budgets are not always sufficient. At Hannover Re, the major-loss burden in the first three quarters of 2022 already exceeded € 1.6 billion, thus using up the entire catastrophe budget for 2022. Overall, the total cost of major losses in 2022 exceeded the budget by € 306 million.
In the last financial year, 2022, the storm Ylenia/Zeynep in Europe in February 2022 and the flood disaster in Australia in March 2022 were primarily responsible for the high major losses.
Hannover Re is responding by raising insurance premiums, especially for natural catastrophe reinsurance. In addition, it is developing new insurance products specifically geared to clients' needs in certain risk regions or focusing on risk-selective lines of business such as natural catastrophe insurance. As part of the treaty renewals, Hannover Re reported that it had achieved an inflation- and risk-adjusted price increase of 8.0 percent.
High inflation as well as extreme weather events such as intense thunderstorms with severe hail adversely impacted the results of insurers and reinsurers alike. Hannover Re achieved significantly higher prices in Continental Europe, especially for loss-affected covers in Germany and France. [...]
In natural catastrophe business the premium volume booked by Hannover Re grew by around 30% in the 1 January renewals. Further growth is expected in the renewals during the year. Prices and conditions improved sharply and in some instances to an extent not seen in decades, owing to the heavy loss experience of the previous year. Prices increased by an average of 30% on a risk-adjusted basis.
This is a significant point that I really like about insurers and reinsurers as a shareholder. Reinsurers benefit from expensive major losses as this causes premiums to rise. Even if major losses and the increased risks due to climate change weigh on profitability in individual years and are, therefore, a reason for falling share prices in the short term, in the long term they act as an economic stimulus package for insurers.
Looking to the future, the management expects Hannover Re to increase its revenue by more than 5 percent in 2023. Net income is expected to be € 1.7 billion or more, representing a growth of 20 percent.
Analysts polled by FactSet Research also expect Hannover Re to massively increase adjusted earnings per share from last year's €11.66. The analysts' expectations for the adjusted profit as published by FactSet are as follows for the following years:
- FY 2024: 12 analysts expect a range of € 15.72 to € 19.52.
- FY 2025: 6 analysts expect a range of € 16.51 to € 22.20.
- FY 2026: 1 analyst expects adjusted earnings of € 19.65.
This means that even the most pessimistic analysts expect profits to grow by more than 40 percent by 2025 compared to the 2022 financial year. Revenue is also expected to rise from € 32 billion to more than €37.7 billion in 2026.
Taking dividends and valuation into account
Hannover Re has been pursuing a two-pronged dividend policy for years. Each year the company pays a basic dividend that is at least on par with the previous year's level. A special dividend supplements this basic dividend if available cash reserves exceed capital requirements for future growth and the management's profit target is achieved. Hannover Re's dividend yield, measured against last year's payout, is 2.9 percent and thus below its historical corridors, indicating a potential overvaluation.
For the 2022 financial year, Hannover Re proposes a distribution of €6 per share, which corresponds to an increase of 4.3 percent. On this basis, the dividend yield is below the average of the long-term corridors, which is why I do not see a buy signal with regard to Hannover Re's dividend yield.
Besides, the Hannover Re share is also fairly sportingly valued. On average, the market has valued the Hannover Re share at a fair value of 12.6 based on adjusted earnings over the past ten years. With a current adjusted P/E ratio of 15.8, the valuation is more than 30 percent above this historical multiple. The Hannover Re share is, therefore, currently overvalued. Only the outlook for rising profits justifies further share price potential. Based on average adjusted earnings per share of € 18.54 expected for 2025, the P/E ratio is only 10.7 and thus far below the historical average, resulting in an upside potential of more than 37 percent.
Conclusion
Even if major losses and the increased risks due to climate change weigh on profitability in individual years and are thus cause for falling share prices in the short term, these catastrophes drive the business of reinsurers in the medium and long term.
In addition to the risks posed by climate change, many investors wonder what interest rate and currency risks Hannover Re is exposed to.
With regard to interest rates, I do not see rising interest rates or an environment with high-interest rates as negative. For one thing, interest rates are still historically low. Furthermore, insurers and reinsurers have existed for a very long time and also have weathered phases of higher rates. Moreover, higher rates can be advantageous for reinsurers. As with primary insurers, Hannover Re receives capital from insurance premiums, which it invests with the highest possible return and, simultaneously, with the lowest possible risk. As interest rates rise, so do yields, especially on government bonds.
However, investors should bear in mind that 42 percent of Hannover Re's capital is invested in the US dollar currency. Insurance companies have benefited from the strong development of the US dollar over the past year. With regard to Hannover Re's 3Q, the growth in gross premiums at constant exchange rates would have been only 13.5 percent instead of 20 percent, as reported. However, these positive currency effects reverse when the US dollar weakens. Investors should nevertheless keep this allocation in mind, given the current weakness of the US dollar against the euro in the coming quarters.
Overall, and to sum things up, the Hannover Re share is unjustly ignored by investors and should receive more attention. It is currently overvalued, but the hope of significantly increasing profits in the coming years can justify the current high share price.
Please note that even though I do not hold any Hannover Re shares directly, I am indirectly invested in Hannover Re through my investment in Talanx AG ( OTCPK:TNXXF ; OTC:TLLXY ), as Talanx holds more than 50 percent of Hannover Re shares.
For further details see:
Hannover Ruck SE: An Overlooked Gem