FBD Holdings Plc- Welcome back to Ireland !!!
Disclaimer: This is not investment advise. Please do your own research !!!
FBD is a local Irish Insurance company that I first wrote about in early 2015 when the stock look cheap. Luckily I didn’t invest back then as 7 months later FBD got already in trouble mainly due to under reserving plus another few skeletons in the closet. A month later, Prem Watsa came to the rescue with a slightly unusual deal structure.
What caught my eye now again (thanks to a friend mentioning the stock) is the relatively weak share price combined with super strong 2019 results and no bounce back from the Covid-19 crisis levels:
The stock is pretty much back where it was in late 2015 but Profits increased more than 100% in 2019 and ROE was around 30% which is exceptional for a “normal” insurance company. It needs to be noted that parts of the profit were reserve releases and higher than usual investment returns.
Recap: The Prem Watsa deal
Just to recap: In September 2015, Prem Watsa saved FBD by extending a 70 mn loan to FBD with a coupon of 11,66%. This was replaced by a 70 mn EUR mandatory convertible bond with 8.23 mn shares that convert if the share price exceeds 8,50 EUR. 2015 ended for FBD with a loss of around 75 mn EUR and a new CEO. 2016, FBD managed already to post a small profit before showing super solid results both in 2017 and 2018.
In 2018, FBD bought back the bond for a total consideration of 86 mn EUR (incl. interest). Instead they issued a 50 mn “Normal” hybrid debt at a rate of 5% which looks like a better deal. As mentioned above, 2019 was an exception.
So what is negative?
As always, I try to shoot a few holes into an investment before considering it more seriously.
- Top line does not grow that much and there is little potential growth on top of GDP growth
- FBD is still a more traditional business through brokers (although Ireland for some reason is mainly a broker market). This is clearly not an Admiral with structural cost advantages.
- They increased risk exposure to 10% of total assets by the end of 2019 (up from ~5% 2017) which might have backfired somehow
- The proposed dividend of 1 EUR per share seems to have been stopped by the regulator
- Negative press following the earnings release as “Greedy”
- Turnaround CEO stepping down this year and is now run by an interim CEO
- P&C insurance in Ireland was/is much more cyclical than elsewhere for whatever reason (weather being one of them, widespread fraud another)
- a significant portion of earnings 2018/2019 came from reserve releases
- of course Covid-19 implications plus fall out from Brexit
- The company is really cheap. I trades at around 6,5x times normalized earnings which for a P&C insurance company is very cheap (see below)
- The turn-around CEO “cleaned up the ship” by strengthening reserves, cleaning up the pension plan, disposing of strange assets etc.
- Now very strong Solvency position with potential excess capital (increase from 126% incl. the Watsa deal in 2016 to 192% in 2019 ex Watsa convertible).
- Irish “champion” as a certain “Brand moat” as many Irish consumers prefer Ireland domiciled insurers
- As a P&C pure play the business is to a certain extent counter cyclical (less motor claims)
- Their background (farmers) seems to implicate higher “affinity” of clients to their insurer than competitors
The CEO issue
On paper, the CEO Muldoon has done everything right. However in 2018 some internal accusations surfaced mostly from the chief of HR. The board of FBD started an official investigation in 2018, but she was cleared shortly thereafter. I am not sure if that has something to do with her decision to leave FBD. The appointment of an interim CEO however shows that the whole episode was not a carefully planned one.
Quick and dirty valuation:
AT 6,75 EUR per share, the company is valued ~240 mn EUR. Shareholders Equity at the end of 2019 was 372 mn EUR or 10,60 EUR per share with little intangibles.
A P&C insurance company as FBD can be modelled quite easily assuming a “over the cycle Combined ratio (Cost and claims as % of Net premium) and normalized Investment income.
At a 90% combined ratio and a 1% return on investments, my normalized earnings would be around 1.05 EUR/share, a very conservative case would be a 95% Combined Ratio and 0,5% investment return which would result in 0,53 EUR/share.
I would add the proposed dividend as “excess capital” to the valuation. Either it gets paid out this year or it remains as excess on the balance sheet and will then be released over subsequent periods.
Assuming a “fair” PE of 12, my price target in the optimistic case would be around 13,60 EUR per share, in the conservative one 7,28 EUR. My “expected” case would be somewhere in between, maybe around book value for simplicity reasons. A quick reminder: Book value is not a good proxy for the value of a financial firm unless returns on equity are sufficient, which in this case is given.
Why is the stock cheap then ?
I can only speculate, but the pretty abrupt exit of the successful turn-around CEO plus the intervention of the regulator might have prevented a bounce back as so many other stocks have experienced. For my personal risk appetite, I can live with these risks compared to the potential upside.
A lot has happened since I looked at FBD 5 years ago. Other than back then, I think despite some risks (CEO, regulator), the stock is now a “good value” with a very good risk/return relationship. With regard to Covid-19 I would not say that they benefit but the business model is clearly less sensitive than most other businesses.
I therefore established a 4,5% position for the portfolio at 6,75 EUR/Per share. I hope to see a total return (incl. dividends) of around 50% within 12-18 months.
Desclaimer & Health warning: This is not investment advice. The stock discussed is illiquid.