The 300 Club

ntact Financial is Canada’s largest property and casualty (P&C) insurance provider, with a market share of approximately 17 per cent. T

he company offers a diverse set of insurance products, including personal auto, personal property, commercial auto, and commercial P&C. Its shares nicely combine the attributes of a growth stock with good dividends.

Intact Financial Corp. (TSX—IFC) is not only Canada’s largest property and casualty (P&C) insurer, it is also one of the industry’s best performers, according to Vancouver-based Odlum Brown equity analyst Benjamin Sinclair.

Citing the company’s historically sound performance, enduring scale, and relatively cheap trading price “given Intact’s long runway”, the analyst reiterates that investors should “buy” shares of the company. He also stands by the 12-month target share price of $100 that he previously assigned Intact.

Intact’s main business is P&C insurance. It offers a diverse range of products, such as personal property and commercial auto coverage. Products are sold through three channels: independent insurance brokers, Intact’s captive broker network, and direct to consumers without a broker. Intact also sells specialty and niche insurance products through its Jevco Insurance subsidiary.

Growth stock beats industry averages

Mr. Sinclair says that over the past decade, the company has grown faster than the industry by 3.9 percentage points per year, all while beating the average industry margin by 3.1 percentage points and the average return on equity (ROE) by 5.8 percentage points.

“Looking ahead, Intact hopes to beat the industry average ROE by five percentage points per year, a number that we view as conservative,” says the analyst.

He lists a couple of reasons for such strong out-performance. Firstly, Intact is exceptionally well managed. The company is a very disciplined underwriter and has historically taken a prudent approach when estimating future losses.

“Intact ranks first among Canadian auto insurers for claims experience, which indicates the company doesn’t cut corners.”

Acquisitions have also been consistently well-integrated into the company, he adds. The other reason for Intact’s out-performance is its scale advantages. Insurance has a number of high fixed costs, such as those related to technology, and Intact’s size makes these costs less burdensome.

Mr. Sinclair notes that the company also enjoys greater purchasing power, which helps reduce claims expenses. Furthermore, Intact has the most claims data, enabling the company to estimate future risk more effectively than its competitors.

Even so, the analyst admits, “The one big concern with Intact is its share price; at roughly 2.2 times book value, Intact’s shares trade at a rich valuation.

“That said, we believe Intact is well worth the premium, mainly because there is so much more room for growth.” Mr. Sinclair also stresses that he predicts Intact will be able to maintain its trading price at the same book value level.

Acquisitions, international opportunities fuel this growth stock

The analyst highlights what he considers Intact’s growth prospects. “The industry is still very fragmented, giving Intact numerous acquisition opportunities, and the company hopes to eventually expand beyond the Canadian borders. In the meantime, the dividend is fairly modest, allowing for capital to be redeployed at very high rates of return.

“Thus, Intact’s book value per share should grow significantly for many years to come, and we expect the company to maintain its rich valuation along the way.”

According to Mr. Sinclair, over the past 30 years, the Canadian P&C market has generated a return on equity of 10 per cent on average.

“Given Intact’s historical out-performance and future goals, we expect the company to earn an average of 17 per cent return on equity. If the company achieves such a result over the next 12 months, its book value per share will grow to nearly $45 after paying dividends.”

Mr. Sinclair touts the insurance industry’s ability to generate “float”, which refers to insurance premiums collected but not yet used for paying claims or expenses.

P&C insurers invest most of their float in fixed-income securities, due to the short-term nature of claims, he explains. For example, Intact allocates just 22 per cent of its investments to stocks, a number that is actually above average for the industry.

“So if interest rates fall, all else being equal, insurers would find their profitability squeezed.”

However, the analyst adds, “To compensate for low returns on their float, insurers tend to increase their premiums when interest rates decline and we’ve seen evidence of that in recent years. Likewise, we would expect more competitive pricing pressure when interest rates eventually recover.”

Ontario is by far the largest market for Canadian insurance in Canada, accounting for nearly half of total premiums. Mr. Sinclair says, “As it stands though, the auto insurance market in Ontario is a regulatory mess, as product, pricing, and even profitability are subject to strict regulation. Tellingly, Ontarians pay the highest auto insurance premiums in the country.”

The provincial government has promised to introduce legislation that would reduce rates, which would appear to be a negative for companies like Intact, but the government’s efforts include actions to reduce claims fraud, and also lower claims benefits on standard policies, the analyst says. “We will be watching closely.”

Investor’s Digest of Canada