Pannonia: After-Tax Profit Beat Expectations

 

 

CIG Pannonia – Earnings Comment

Recommendation: Accumulate (unch.)

Target Price (12-month): HUF 484 (unch.)

Current Share Price: HUF 421

 

Pannonia reported a IFRS consolidated after-tax profit of HUF 545 mn in Q4/18 versus HUF 330 mn in the same period of a year earlier. As a result, CIG Pannonia reported after-tax profit of HUF 2,106 mn for 2018 compared to HUF 349 mn clean after-tax profit in 2017. We note that Pannonia booked one-off items in 2017 including a non-recurring gain of HUF 3.2 bn arising from the acquisition of MKB Insurance companies, the result of assets held for sale of HUF -475 mn and losses of HUF 473 mn on interest bearing shares.

 

The available solvency capital ratio (based on own capital plus the present value of future expected profits) of the life and non-life insurance segments were 346% and 183%, respectively, as at 31 December, 2018, so both segments fulfilled the 150% Solvency Capital adequacy requirements of the Supervisory Authority despite revaluation losses on government papers and KONZUM shares.

 

Outlook: We keep our estimate for total annualized premium of new life policy sales at HUF 3.2 bn in 2019 (flat on 2018), with the risk that new alternative savings instruments (like pension government bonds) may hamper penetration of UL product going forward. As a result of reclassification of existing single premium insurance contracts) we raise our GWP forecast for 2019 from HUF 24.3 bn to HUF 26.2 bn.

 

With improving non-life cost ratios, strict cost discipline and increasing earnings contribution from asset management, we remain confident that Pannonia will be able to deliver HUF 2.16 bn after-tax profit for 2019, implying an EPS of HUF 23 (-5% YoY). We also expect that Pannonia could generate after-tax profit of ca. HUF 2.41 bln by 2021, implying a 3-year clean EPS GAGR of 4% on 2018 EPS, though without incorporating any additional profits that can potentially arise from deeper cooperation with KONZUM. The risk to our earnings projection is a lower than anticipated renewal ratio in the life segment going forward due to the expiry and the increase in the surrender of life policies contracted ten years ago en masse, and to new savings forms sponsored by the government. We believe further cost significant savings are hard to make in light of ballooning IT costs and wage increases.

 

Although rising interest rates and floundering KONZUM shares are currently weighting on Pannonia’s comprehensive results, the insurer should benefit from higher yields at which it will be able to invest newly generated premiums in the future, while asset management fees may stabilize. Notwithstanding huge fluctuations time-to-time in other comprehensive results caused by mark-to-market revaluation of available for sales securities held on B/S (government bonds and KONZUM shares, in particular), Pannonia shouldn’t change its dividend plan for the forthcoming years (dividend can be paid from the after-tax profit and retained profits until the total own equity is higher than the share capital).

 

Pannonia intends to distribute not only the parent (life insurance) company’s unconsolidated full annual net profit, but also the parent company’s entire retained profit reserve to shareholders. At the end of last year, the profit reserve of the life insurance company including the profit after tax for the year 2018 amounted to HUF 1.73 bn, which should imply dividend of HUF 18.4 a share (DIVY of 4.4%) compared to market expectations of HUF 20 which would correspond to a slightly higher dividend yield of 4.7% based on the current share price. Although the dividend that can theoretically be paid is only HUF 1.5 lower than the average of analysts’ expectations, it is a big challenge facing the insurer to pay HUF 20 in the prevailing accounting and legal framework. (For example, share buybacks are also subject to the same rules as dividends, ie whether the insurer pays dividends or repurchases own shares, both of which are limited to the amount of accumulated retained earnings.)

 

That said, it is also conceivable that the dividend will exceed HUF 20 per share next year. To wit, Pannonia does not necessarily need to increase its after-tax profit, just keep it flat compared to last year's figures. As there is new acquisition target on the insurer's investment horizon, and the former hopes that KONZUM will effectively support Pannonia's expansion in the domestic insurance market have not yet come through, while the insurer is clearly over-capitalized and thus it should be able to pay out all its available retained earnings to shareholders. The non-life business had profit reserves in a total of HUF 1.2 bn at the end of last year, which can be transferred to the parent company as dividend, and then paid out fully to the parent company’s shareholders, as well as the net earnings coming from the fund management company (around HUF 0.3 bn), while the life business itself is also expected to achieve HUF 0.9-1.0 bn after tax profit next year, which can also be paid out fully to shareholders. All this together creates the base for the insurer to pay approx. HUF 24.8 as share dividend in 2020, implying a DIVY of 5.9% on our estimate. Increasing dividend would certainly benefit the principal owners controlling management rights and KONZUM, and thus the minority owners.

 

What is alarming, however, is that the share price performance is daunting. Over the past year Pannonia shares have underperformed the European insurance benchmark index (SXIP) by 7% in terms of total return in EUR, signaling that share price rally ahead of the news that KONZUM would inject capital into the insurer has waning conviction behind it. Investors is seen preferring to stay on the slidelines bemoaning that Pannonia’s goals as to where it is going with respect to its excess capital, and the challenges and risks that this involves are unclear. Investors tend to invest in companies that are undervalued compared to their growth opportunities that can be exploited at costs lower than the required rate of return, but the possibility of higher dividend payments going forward might send a bad message that Pannonia cannot utilize its excess funds arising from the last year’s capital increase, which currently is more of a burden than an opportunity to finance growth, and in fact it only worsens the return on equity. No doubt it would be more beneficial for Pannonia to reinvest the excess funds back into business development, but it seems that it has used only its own internally generated funds so far for this purpose while keeping all its excess funds in bank deposits and government bonds in the absence of new acquisition targets.

 

We believe that the key domestic driver (growth) is holding up, the fundamental backdrop for the insurance sector looks healthy, the weakness of the competitors within some savings market segments could turn into a tailwind, but valuation likely reflects a lot of lucrative business opportunities already.

 

We leave our 12-m TP at HUF 484 a share (implying a 15% upside potential from the current share price). We keep our Accumulate rating on Pannonia.

 

Pannonia is currently trading at a P/E multiple of 18.5x based on 2019E earnings and a P/BV multiple of 2.3x on yearend-2018 book value. On the basis of 2018E P/E ratio Pannonia is trading at a 68% premium over peers’ corresponding multiples, while its P/BV multiple implies a 77% premium over peer’s average P/BV. Pannonia’s relative reach valuation in terms of P/E clearly reflects investors’ firm belief that the insurer could extract potentially significant synergies from the partnership with KONZUM. Evidently, in order for investors to justify this reach valuation, Pannonia has to provide greater disclosure about how to use its excess cash to develop fast its businesses on a sustainable basis.

 

Attila Vago
Senior Analyst

CONCORDE SECURITIES LTD.

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55-61 Alkotás street, H-1123 Budapest.
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MEMBER OF THE CONCORDE GROUP

 

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