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Morningstar | Genworth’s Stronger 1Q19 Earnings Hide Higher Delinquencies, FVE Unchanged

Stronger investment markets helped no-moat Genworth generate impressive first-quarter 2019 earnings. Statutory net profit after tax, or NPAT, was materially higher at AUD 47.8 million, compared with AUD 8.4 million in first-quarter 2018. An unrealised gain of AUD 25.5 million on its investment portfolio was the primary driver of the big jump in earnings. Underlying NPAT was also higher but by a more moderate, albeit still impressive, 12.1% to AUD 22.3 million. Underlying NPAT also benefited from the firm’s investment portfolio generating an aftertax realised gain of AUD 3.5 million. However, the company continues to face slowing in overall housing finance in Australia but it’s gaining a higher share of the faster growing first home-buyer finance market. More negatively, continuing house price falls led to higher delinquencies in the quarter, although we expect there is a seasonal element to this. An analysis of these conflicting indicators results in no change to our fair value estimate of AUD 2.55 per share. At our fair value, the company is forecast to have a fully franked 2019 dividend yield of 8.6%.

We expect underlying NPAT to grow by 1.4% in fiscal 2019, boosted by insuring a higher proportion of Australia’s slowing housing finance growth, reduced impact of 2017 earnings curve assumption changes, stronger performance in the company’s investment portfolio offset by higher claims. The inclusion of unrealised gains in its investment portfolio should see more impressive growth in statutory NPAT. Management reaffirmed its guidance of net earned premium, or NEP, increasing in the range of negative 5% and positive 5% and a loss ratio (net claims/NEP) of 45% to 55%. A combination of the reduced impact of earnings curve assumption changes in 2017 and its recent initiatives garnering a higher share of the first-homeowners are the primary drivers of our forecast NEP growth rate in 2019 of 3.6%. However, this is somewhat offset by a higher expected loss ratio.

Continuing house price falls prompt an increase in our loss ratio for 2019 to 53% from 51.5%. Compared with first-quarter 2018, Genworth incurred an 8-basis point increase in its delinquency rate (number of delinquencies/number of policies in force excluding excess of loss insurance) to 57 basis points. The recently stronger employment growth and lower unemployment rates in each Australian state over the year, other than in Queensland and South Australia, were not enough to offset the continuing and recently more broad-based house price falls. Genworth’s delinquency rate increased in each state, with a significant jump in Western Australia (17 basis points) and Queensland (7 basis points), where delinquencies were primarily in regional and rural areas. The delinquency rate also increased by 8 basis points in New South Wales, but from a low base, with NSW still enjoying the lowest delinquency rate of 41 basis points (Western Australia is the highest with 105 basis points). These conditions prompted management to increase its claims reserves by AUD 10.2 million in the quarter.

Other than the continuing house price falls, the company also faces the near-term risks of renewing its largest customer, the Commonwealth Bank. Commonwealth Bank accounted for 60.1% of the company’s gross written premium in 2018. We assume the company will retain the Commonwealth Bank contract on broadly the same terms but, so far, management has not provided the market with an update on how the negotiations of this contract are progressing. The other near-term uncertainty revolves around a change in management, with the announced resignation of CEO Georgette Nicholas. However, the transition appears to be amicable, with Ms Nicholas remaining CEO until a successor is found and promising to remain as an employee of the company for a period to assist in the orderly transition to the new CEO. A search for a new CEO will be conducted both in Australia and internationally.

On a more positive note, the company continues to maintain a strong balance sheet, with its prescribed capital amount, or PCA, ratio improving to 2.01 times as at March 31, 2019, from an already high 1.94 times at Dec. 31, 2018. The lower composition of high loan/value ratio loans on which it is writing insurance, as well as the seasoning of older policies, have resulted in a continuing fall in its probable maximum loss amount. The falling probable maximum loss amount is the main driver of its high PCA ratio.

We expect the company to step-up its share buyback program on the back of this improvement. Genworth commenced a new on-market share buyback of up to AUD 100 million in February 2019 and management now indicate they will seek shareholder approval to acquire up to 100 million shares (at current prices equating to AUD 247 million worth of shares) over the next 12 months. We had forecast the company will conduct AUD 100 million worth of share buybacks in each of the next three years. We now forecast the company will buyback AUD 370 million worth of shares, with most shares bought back in 2019 and 2020.