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Morningstar | We Think AXA's 9-Month Result Shows Some Underlying Problems With Integrating XL Acquisition

AXA reported nine-month indicators for 2018, with a 2% increase in property and casualty commercial lines to EUR 12.4 billion, which is where we think the market is focused. The stock looks to us to be undervalued, trading at around 0.7 times book value, though we recognise there are some uncertainties surrounding the business. We maintain our EUR 26 fair value estimate and no-moat and stable moat trend ratings.

The 1% rise in property and casualty revenue was mainly driven by a 2% increase in commercial lines. We think there are basically a couple of items to take away from this earnings release. The first of these is the acquisition of XL that closed Sept. 12. The problem here is that large losses have come in well ahead of budget, at around EUR 200 million; this is twice the amount the business would typically expect to see in this quarter.

The second item that we find a little concerning is the more general condition of the property and casualty portfolio. We have seen a 2% drop in personal motor revenue in France and a 1% drop in personal nonmotor. Given that pricing in French personal lines is up 160 basis points, this is purely volume-driven.

Within this first item of of larger losses, the preliminary claims estimate from Hurricane Michael in the United States in October is $200 million net of reinsurance. The concern for the market is that AXA announced that this is 2 times the level of natural catastrophe charges that it would typically expect to experience in the fourth quarter. The natural catastrophe events occurring in the third quarter included Typhoon Mangkhut in Hong Kong, Typhoon Jebi in Japan, Hurricane Florence in the U.S., and Typhoon Trami in Japan; all came in, along with a few others, at an estimated loss charge of EUR 300 million before tax and net of reinsurance. Again, these events were equivalent to around twice the level of natural catastrophe charges that the business typically expects to experience in the third quarter.

Unfortunately for AXA, on the combination with XL, the business had guided to an annual large loss figure of around EUR 1 billion, and clearly, at EUR 500 million, the market and we are concerned about the ability of the business to maintain and stick to this budget. Management has reiterated that the budget stands, but these nine-month indicators are certainly giving us pause.

The second item that we find a little concerning is the more general condition of the property and casualty portfolio, with a 2% drop in personal motor revenue in France and a 1% drop in personal nonmotor. Given that pricing in French personal lines is up 160 basis points, this is purely volume-driven. This is a competitive environment at the moment and has intensified since 2014 with the introduction of the Hamon law, which has given consumers greater power in terms of addressing cost of proceedings via associations. However, we think that the introduction of such a law and the increased competition would have affected pricing, and not volume, and while we think this may have had an impact for some time, we are now four years on, and this seemingly should have bedded in.

We are not revising our fair value estimate at the moment, but the business does seem to be having some issues with its natural catastrophe exposure with the acquisition of XL, and there is a volume story in more traditional lines of European P&C. Management claims stable pricing in U.S. commercial, where we have been concerned about motor fleets. Nothing directly points otherwise, but though European commercial pricing looks to have improved, the breakdown of revenue points to a continued troubling situation in European commercial motor. Given the ties between these two (U.S. and Europe) in large-scale business, we are sceptical that management’s claim of U.S. fleet stability is really the case.

AXA is a bedding-in story. XL was a very large acquisition and away from its traditional stomping ground. It is moving the business significantly towards a global commercial property and casualty player, likened to Zurich. However, while these risks are aggregated, and in general require dedicated underwriters to cover corporate accounts, intense competition has entered this arena recently, and at the moment, we don't see that this competition has fully abated.