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Morningstar | Steadfast Proposes Strategic Relationship with IBNA, Boosting Broker Numbers. FVE AUD 3.00 Unchanged

In late June, no-moat insurance broker, Steadfast Group, confirmed negotiations with Insurance Brokers Network Australia Limited, or IBNA, to form an alliance. IBNA is a large network of insurance brokers in Australia, with members billing about AUD 1.3 billion in gross written premium annually. For comparison, Steadfast’s insurance broker network billed AUD 5.3 billion of gross written premium in fiscal 2018. The IBNA deal is at an early stage, with the expected impact on Steadfast to be clarified when the transaction size and timing is confirmed. As the IBNA transaction is not complete and could fall over, at this stage, we do not include the proposed transaction in our forecasts or valuation. IBNA agreed to support its member brokers joining the Steadfast broker network and renounce their rights to future rebates from professional service fees payable by Steadfast as a result of business placed by IBNA members with Steadfast’s insurance underwriting partners.

Steadfast’s fiscal 2019 results will be issued in mid-August. We forecast a cash NPAT of AUD 113 million, ignoring amortisation expense of AUD 25 million. We forecast total fully franked dividends of AUD 8.5 cents per share for fiscal 2019 with the final dividend of AUD 5.3 cps. Consensus estimates are broadly in line. We maintain our fair value estimate of AUD 3.00 and at current prices the stock screens as overvalued, trading 20% above our valuation. We like Steadfast’s growth by acquisition, but we are cautious of increasing risks of overpaying. Over aggressive expansion and execution risk remain key concerns for shareholders. Despite our concerns we expect attractive future earnings growth, underpinned by acquisitions, better operating efficiency, further strength in insurance pricing and leveraging the firm’s proprietary advanced technology. Despite a positive outlook, our no moat rating is unchanged. We forecast average EPS growth of an attractive 9% per year for our five-year forecast period.

The IBNA agreement is subject to further due diligence by Steadfast, agreement on restructuring issues and regulatory approvals. Steadfast offered to pay IBNA brokers joining its network an initial consideration equal to fiscal 2019 professional service fees generated by IBNA members (estimated by Steadfast to be AUD 9.13 million) multiplied by 8.32. This gives an a initial purchase price of AUD 76 million.

The initial purchase consideration is likely to involve the issue of Steadfast shares on completion, estimated by Steadfast at 23.1 million shares based on a 30 day volume weighted average price to June 25, 2019 with IBNA members receiving consideration in proportion to the total rebate each member receives from IBNA and the A&I Member Services Pty Limited (AIMS) joint venture. The issue of approximately 23 million new Steadfast shares at approximately AUD 3.30 per share would increase the share count by approximately 3%.

The initial consideration is subject to adjustment if not all IBNA members join the Steadfast network or if the professional service fees generated by IBNA members in fiscal 2019 varies from the estimated AUD 9.13 million. Estimated service fees are based on gross written premium being approximately AUD 1.4 billion. Other conditions include appropriate warranties and indemnities by Steadfast depending upon the final structure of the transaction.

IBNA became a national association in 1994 and has grown into an unlisted public company governed by its Board of Directors. IBNA has over 90 broker members in Australia who are locally owned, compared with Steadfast’s 332 brokers in its Australian network at Dec. 31, 2018. IBNA’s broker network distribute insurance products from mainstream insurers, such as AIG, QBE, Zurich CHUBB, Lloyds, CGU, Allianz and others.

In early May 2019, Steadfast confirmed acquisitions valued at over AUD 100 million had been undertaken to date in fiscal 2019. Steadfast announced it had made 10 new broker equity investments, nine equity “step ups” in existing holdings and two “hubbings”. Where appropriate, Steadfast merges, or integrates, back office functions of existing of Steadfast brokers – what the firm refers to as “hubbed”. New investments to May 1, 2019 included 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.

At May 1, 2019 Steadfast reported a strong pipeline of acquisition opportunities with the firm holding approximately AUD 85 million in unutilised debt facilities, plus free cash flow. Corporate debt outstanding of AUD 330 million at Dec. 31, 2018 represented a group gearing ratio of 24%, below the firm’s approved maximum of 30%. Cashflow remains strong with the conversion of net profit after tax (excluding amortisation) into cash remaining high around 100%. Cash and cash equivalents stood at AUD 115 million at Dec. 31. 2018.

The IBNA transaction, if completed, would be the largest acquisition since the acquisition of Whitbread Insurance Group for AUD 95 million in December 2017. Funding the IBNA transaction by the issue of shares would not reduce the unutilised debt facility, however issuing new shares potentially dilutes EPS and we need to wait for further details on the IBNA acquisition to determine whether the deal is EPS accretive or not.