EUR 850.00 For Business Accounts Only

Morningstar | Steadfast Well Positioned to Benefit From Attractive Earnings Growth; FVE Unchanged at AUD 3.00

Our positive long-term view on no-moat Steadfast Group is intact following our regular post-results management meeting. This is based on the firm’s attractive growth options, resilient revenue and earnings, the high proportion of long-standing small to midsize enterprise customers, impressive renewal rates, and high customer switching costs. We like the company's attractive earnings upside based on robust underlying fundamentals, but aggressive expansion and execution risk remain key concerns. The stock is fairly valued, trading in line with our AUD 3 valuation.

We expect EPS growth to average an impressive 9.2% per year over the next five years based on solid revenue growth from the existing businesses, recent domestic acquisitions, the investment in Hamburg-based global insurance broker unisonSteadfast, and other equity broker investments in Australia. We like the significant investment in technology and expect meaningful improvement in productivity. We expect the combination of good revenue growth, averaging 12% per year to fiscal 2023, and a more efficient cost base will support net margin and thus EPS growth. Our fiscal 2019 underlying EBITA forecasts of AUD 190 million and underlying NPAT of AUD 86 million sit in the middle of the guidance range. Our fiscal 2019 cash NPAT forecast of AUD 111 million and fully franked dividend of AUD 0.08 per share are unchanged.

Solid performance of the firm's equity investments in brokers and underwriting agencies, and improved insurance pricing continues to support earnings growth, with gross written premium, or GWP, reaching a record AUD 5.3 billion in fiscal 2018. The approximate AUD 300 million, or 6%, increase in network broker GWP compared with a year ago was sourced 3% from organic growth, 1% from new equity brokers, and 2% from additional authorised representatives. Anecdotal evidence suggests that commercial insurance prices continue to increase, and we expect further strengthening during the next two years.

Management have been very selective and disciplined with acquisitions since listing in 2013. Approximately AUD 500 million in acquisitions have been made since the IPO, with another approximate AUD 1 billion of potential acquisitions rejected. The balance sheet will remain strong as long the firm’s acquisition discipline is intact. As at June 30, 2018, the firm reported net assets of AUD 1 billion, with goodwill and identifiable intangible assets accounting for the bulk of net assets. Strong operating cash flow was a key highlight, with AUD 96 million, or 99%, of cash earnings converted into cash in fiscal 2018. The majority of the cash flow is available for reinvestment in new businesses or acquisitions, with the balance paid to shareholders based on a 60% payout of cash profit.

Balance sheet cash of AUD 77 million at June 30, 2018, combined with the AUD 109 million unutilised corporate debt facilities, support the firm’s acquisition growth strategy and future dividend payments. Total group gearing of 17.5% was well within the firm's maximum ratio target of 30%. The corporate gearing ratio, or corporate debt/corporate debt plus equity, cap of 25% was not troubled at June 30, 2018, remaining steady at 14%. Steadfast is a very capital-light business with minimal capital expenditure requirements.

Steadfast's underwriting agency group increased impressed in fiscal 2018, with GWP increasing an outstanding 18% to AUD 914 million from AUD 777 million in fiscal 2017, driven by price, volume, and acquisition growth. Property and business lines were particularly strong, and we expect more of the same during the next two years at least. The underwriting agency group is the largest group in Australasia with 26 agencies, and we expect GWP will break the AUD 1 billion mark in fiscal 2019 on the back of acquisitions and further premium rate increases.

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. Long-standing CEO Robert Kelly is the driving force behind the group’s success, and his scheduled retirement in December 2020 could detract from business momentum, particularly as many of the group investment strategies are long-term-focused. Potential future goodwill write-downs would damage the stock’s high P/E ratio, which is currently around 21 times, causing shareholder value destruction. But this is not our base case, as we are confident that management's disciplined approach will continue, with most acquisitions to come from within the firm's broker network or from long-term partners.