Pannonia - The Italian fiasco

CIG Pannonia – Earnings Comment

Recommendation: Neutral (prev. Accumulate)

Target Price (12-month): HUF 315 (prev. HUF 496)

Current Share Price: HUF 320

 

Pannonia reported an IFRS consolidated after-tax profit of HUF -1,118 mn in Q2/19 compared to HUF 540 mn in the same period of a year earlier mainly due to unexpected significant claims in the non-life segment related to Italian cross-border gaming surety insurance, which resulted in a net loss of HUF 692 mn, and to the realized loss of HUF 1,057 mn on the termination of KONZUM shares (owing to the merger of KONZUM Plc into OPUS Global Plc).

 

In the first six month of 2019 Pannonia generated a consolidated after-tax loss of HUF 610 mn compared to an after-tax profit of HUF 615 mn in the same period of last year. The life insurance business brought HUF 1,152 mn after tax profits in H1/19 vs HUF 805 mn in H1/18 (+43% YoY). Excluding dividends of HUF 1,127 mn paid by the non-life segment from its earnings generated in the previous years and dividends of HUF 342 mn from the asset management company, while adding back realized losses of HUF 1,059 mn on KONZUM shares the life segment reached ca. HUF 742 mn underlying after-tax profit in H1/19 vs. ca. HUF 550 mn in H1/2018 (+35% YoY). Meanwhile, the non-life segment’s after tax loss amounted to HUF 275 mn in H1/19 compared to after-tax profit of HUF 410 mn in H1/18, and asset management business delivered HUF 159 mn after tax profit vs. HUF 193 mn in H1/18.

The insurer’s shareholders’ equity increased from HUF 17.39 bn to HUF 17.96 bn (+3% YoY) on the back of the life segment’s earnings contribution.

 

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 321% and 151%, respectively, as at 30 June, 2019, so both segments fulfilled the 150% Solvency Capital adequacy requirements of the Supervisory Authority despite revaluation losses on government papers and KONZUM shares.

 

Outlook: Total annualized premium of new life policy sales might exceed our original expectation of HUF 3.0-3.3 bn and end up amounting to ca. HUF 3.5 bn in 2019 (+10% YoY). We expect Pannonia to remain highly committed to keeping a tight lid on controllable operating costs especially in the light of unexpected claims and related costs arising from gaming surety activity in Italy.

 

We expect the non-life segment to generate losses in the region of HUF 70 mn at best this year due to huge losses recorded on gaming surety activity in H1, while realized losses recorded as investment expenses in H1 on terminated KONZUM shares should hinder the life segment’s ability to generate as much profit as expected previously. In the second half of 2019, we believe the life segment should generate as much underlying earnings as in the first half of the year (ca. HUF 600 mn), and the non-life segment should reach HUF 200 mn after-tax profit, provided that there will be no further provisioning needs for the loss-making gaming surety product in Italy. The asset management is expected to report somewhat lower profit in the remainder of the year (HUF 120 mn on our estimate) due to global stock market turbulences. Putting it all together, Pannonia should have an after-tax profit of as much as HUF 920 mn in H2/19, with which its full-year reported after-tax profit may arrive at HUF 300 mn, while its net profit adjusted for one-off items may amount to HUF 1.5 bn compared with our previous estimate of HUF 2.1 bn. We still believe that Pannonia could generate net profit of ca. HUF 2.4 bn by 2022, implying a 4-year EPS GAGR of ca. 3-4%.

 

As the capital reduction does not have an effect on retained earnings generated in the life segment in the previous years, the base for dividend payments remains theoretically high allowing Pannonia to keep dividend at approx. HUF 25 a share going forward (implying ca. 8% DIVY based on the current share price). Nevertheless, there is absolutely no guarantee that Pannonia will keep this high dividend next year taking into account the significant loss generated in the non-life segment recently.

 

We earlier stressed that if Pannonia fails to make significant inorganic steps within a foreseeable future, we will feel it appropriate to reduce significantly our TP. Clearly, Pannonia’s mid-cap status and rising speculative purchases of its shares by local individuals have so far helped shield the insurer’s ca. EUR 100 mn market cap from global swings in sentiment. The share price was holding firm supported by heightened expectations that Pannonia could deliver outstanding earnings growth by forming a mutually fruitful cooperation with the Konzum Group. Local investors got enamored by the extent of participation of the Konzum in a large capital injection into Pannonia taking place last year that the insurer was believed to use for value-creative acquisitions. With caution thrown to the wind, the share price got highly inflated, bearing little relation to the insurer’s intrinsic value beyond a certain level. There seemed that regular market participants were engaged in a speculative exercise which was not supported by conventional valuation techniques. Fear of missing out on what could be an once-in-a-lifetime opportunity spurred more speculation, drawing an increasing number of participants into the fold and making the stock more susceptible to herd behavior. In addition, as a domestic mid-cap company drawing little attention from international institutional investors, Pannonia is usually slower to react to global sentiment. The stock is not part of any EM strategies or ETFs, so there is typically no selling pressure when global markets turn south.

 

That said, concerns are mounting among investors that earnings weakness in the non-life segment and an impending slowdown in economic activity and thus in savings (hence customers’ presumably less appetite for risk insurance products) could drag down the insurer’s profitability, and that the insurer is on a path toward lower earnings growth. Yet, Pannonia had decent new life insurance sales growth in H1/19, which was much better than expected, so that is a clear counter act, suggesting that the insurer’s return to profit may be on track for the second half of the year. That is why we do not expect there to be any kind of persistent decline in profitability is reasonable to assume for the coming years.

 

Even so, questions are being asked whether Pannonia really has the ability to take risk to succeed in expanding niche market segments abroad, and, if not as recent evidence shows in Italy, what else would be necessary to keep earnings performance prominent, and whether it apparently has no enough capital base to take meaningful risk why so high multiples should be applied for valuation. 

 

Pannonia trades at 100x 2019 earnings (14.3x 2020 prospective earnings) and 1.8x on a current P/BV basis, compared with peers’ corresponding multiples of 10.0x and 1.1x. Evidently, there is the risk, especially after earnings miss, that Pannonia’s multiples converge fast towards the market and industry peers’ lower valuations, even if it offers one of the highest dividend yields in the regional insurance sector.

 

But now that it reported significant losses in the non-life business and there is no sign of deepening cooperation with KONZUM (OPUS) that would result in higher profit growth for the insurer in the short term, we no longer believe that Pannonia will be able to live up to investors’ elevated expectations and no longer believe that the insurer could extract potentially significant synergies from the partnership with its minority shareholder KONZUM (OPUS), or will be able to make another meaningful acquisitions in the foreseeable future, either. We are of the view that if OPUS were really interested in exploiting any potential synergies with Pannonia, they would have already begun to forge a closer business relationship. In the total sale of insurance policies sold, the share of bank channel (which reflects well how fast cooperation between Pannonia and the financial service providers controlled by the OPUS Group develops) dropped 9pps on the year, although it should have actually risen. It seems that the financial service providers within the OPUS group are increasingly focusing on meeting the financing needs of the group’s own industrial members, and thus they seem to pay less attention to deepening partnership in non-core activities. If we are right, Pannonia has no other option but to grow only on its own (forming a new financial intermediary company clearly reveals this trend). That, however, might not be enough to develop the growth of its businesses as fast as required in order for investors to justify its hefty valuation. If Pannonia were to make an acquisition today, it would in fact be too late, given that it would take at least a year to complete the transaction and it would take another year to fully integrate the acquired assets into the group's operations. So the other big hope that Pannonia will take the lead in consolidation among smaller domestic insurance carriers is also slowly disappearing.

 

Putting it all together, we expect Pannonia to remain overcapitalized and see a slowdown in the insurer’s earnings growth for the coming years but we believe it will be able to keep on paying handsome dividends to shareholders. Given a lower growth prospect, it is difficult to justify Pannonia’s currently lofty valuation. Therefore we cut our 12-m TP from HUF 496 to HUF 315 a share, while downgrading our rating on the stock from Accumulate to Neutral.

 

 

 

Attila Vago
Senior Analyst

CONCORDE SECURITIES LTD.

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

 

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