EUR 850.00 For Business Accounts Only

Morningstar | Steadfast Benefits from Technology Investment and Insurance Pricing. FVE AUD 3.00 Unchanged. See Updated Analyst Note from 10 May 2019

Our positive long-term view on general insurance broker, Steadfast Group, remains firmly intact following our regular post result management catch-up. Despite a modest fully franked dividend yield around 3%, the firm offers attractive earnings upside due to robust underlying fundamentals and a focus on growth--both organic and acquisition. We expect earnings growth to be underpinned by better operating efficiency, continued strength in insurance pricing and leveraging the firm’s proprietary advanced technology. Despite our positive view, our no-moat rating and medium uncertainty ratings are unchanged.

Since going public in August 2013, Steadfast has delivered strong growth, primarily from acquisitions but also organically. First-half fiscal 2019 EBITA growth of 21% on the previous corresponding period was driven by 13% organic growth and 8%, acquisition growth. Steadfast’s EPS growth is partly due to its successful “roll-up” broker network strategy with average group EPS growth of 13% per year since listing. Based on Morningstar data, total shareholder returns average an impressive 21% per year for the past five years.

Over-aggressive expansion and execution risk remain key concerns for shareholders. We forecast underlying EBITA of AUD 193 million in fiscal 2019, up 16% on fiscal 2018, and our fiscal 2019 cash profit forecast of AUD 113 million is 16% higher than a year ago. We maintain our fair value estimate of AUD 3 per share and at current prices the stock screens modestly overvalued, trading 9% above our valuation. Our average EPS growth is an attractive 9% per year for our five-year forecast period.

There is no change to our forecast dividend of AUD 8.5 cents per share for fiscal 2019, representing a modest yield of 2.6% fully franked. Consensus estimates for fiscal 2019 are broadly in line with our forecasts. The firm’s fiscal 2019 target dividend payout ratio remains at 65-85% of underlying NPAT. Our forecast payout is 77%.

Fiscal 2019 guidance was recently confirmed with underlying EBITA of AUD 190-200 million and underlying NPAT of AUD 85-90 million. Our underlying NPAT forecast is AUD 75 million after allowing for AUD 22 million in amortisation expense. Guidance is subject to insurers continuing to deliver modest premium rate increase, increasing contribution from Steadfast Client Trading Platform, or SCTP, and ongoing technology investment. Global general insurer QBE Insurance Group recently confirmed average premium rate growth of 6.6%, excluding CTP, for the March 2019 quarter in Australia and New Zealand.

There is a lot to like about Steadfast’s growing insurance broker and insurance underwriting business model. The firm is investing for the long term with state-of-the-art technology underpinning the growing broker network. Our growth expectations are based around the firm’s rollout of the in house developed SCTP, expansion from bolt on and larger sized acquisitions, further strengthening of insurance pricing in Australia and New Zealand and underlying economic growth. Longer term we see upside in the firm’s investment in global insurance broker “unisonSteadfast.”

unisonSteadfast is a global insurance broker network with 230 brokerages across 130 countries generating over USD 250 billion of GWP annually. Steadfast has a 40% equity holding and over time intends to use existing relationships with global insurers to coordinate product distribution across unisonSteadfast, worldwide. It will probably be several years before returns from the unison Steadfast investment make a meaningful contribution to group earnings.

Steadfast acquisition activity continues at pace with over AUD 100 million in acquisitions to date in fiscal 2019. Steadfast has made 10 new equity holdings, nine equity “step ups” in existing holdings and two “hubbings”. Where appropriate, Steadfast merges, or integrates, broker back office functions of existing of Steadfast brokers--what the firm refers as “hubbed.” New investments include CBN, an authorised representative network, HMIA, a heavy vehicle underwriting agency, and Macquarie Pacific Funding where Steadfast acquired the remaining 50% of equity. Steadfast typically aims to take an initial 50% equity interest in equity brokers, with ownership in the 60%-80% band the sweet spot.

Steadfast maintains a strong pipeline of acquisition opportunities and currently holds approximately AUD 85 million in unutilised debt facilities, plus free cash flow. Corporate debt outstanding of AUD 330 million at Dec. 31, 2018 represents a group gearing ratio of 24%, below the firm’s board approved maximum of 30%. Cashflow remains strong with the conversion of net profit after tax and amortisation into cash remaining high around 100%. Cash and cash equivalents stood at AUD 115 million at Dec. 31. 2018.

Since going public in August 2013, Steadfast has added 155 brokers and lost just six to December 2018. Steadfast is the largest insurance broker network in Australia with 332 brokers holding an estimated 28% market share of the Australian intermediated general insurance market and a total of 388 brokers including New Zealand. Steadfast remains focused on SME’s with 84% of its customers base in the SME sector.

We expect EPS growth to average an impressive 12% per year over the next five years based on solid revenue growth from the existing businesses and new equity broker investments. Most importantly, rapid improvement in productivity will be driven by the firm’s significant investment in technology. Long-term tailwinds include further improvement in insurance premium pricing and broader economic growth in Australia and New Zealand. The combination of good top line revenue growth and a more efficient cost base will deliver forecast net margin improvement, and consequently, EPS growth.

Key risks include the pricing cycle turns down, overpaying for assets, integration risks, brokers depart the Steadfast network, underwriters expand into agency and or broker segments and Steadfast’s Asian expansion strategy fails. Potential future goodwill writedowns would damage the stock’s high P/E ratio, currently around 23 times, causing shareholder value destruction. But this is not our base case.