Following a period of weakness in the share price, we recently placed a BUY on AUB Group (ASX:AUB) in The Dynamic Investor. Despite the recent upheaval in equity markets, AUB shares have held on remarkably well. We believe that this is due to the defensive nature of its earnings base. In particular, earnings growth is derived from continued organic tailwinds as well as management’s ability to successfully integrate acquired businesses.
Whilst these strong fundamentals have not diminished in light of recent equity market conditions, we assess whether the current risk-reward balance is still favourable.
About AUB Group
AUB is the largest equity-based risk management, advice and solutions provider in Australasia. The Company operates an ‘owner-driver’ partner model (i.e. where it hold equity stakes in partner businesses). AUB has an ~11% share of the intermediated general insurance market; and ~22% share of the general insurance SME segment in Australia. AUB’s business model is highly cashflow generative and carries no insurance risk, unlike the general insurers.
The Company presently operates five segments, with Insurance Broking (Australia) the main contributor to group profit. The other operating divisions include BizCover, Insurance Broking (NZ), Underwriting Agencies and Tysers (a Lloyd’s wholesale broker).
Key Fundamental Drivers
Earnings Expansion Delivered from Both Organic and Acquisitive Growth
At the FY23 results release, the Company provided FY24 underlying profit guidance in the range of $154m – $164m. This represents growth of 19.3% – 27.0% over FY23. Importantly, the guidance is comprised of organic growth of ~13%, as well as growth from acquisitions,
The strong rate of organic growth reflects the benefit of commercial premium rates. The premium pricing cycle has remained at the ‘hardening stage’ for the last 3-4 years and is expected to last another ~2-3 years. A key factor underpinning this is that the major insurers are still implementing (on average) double-digit percentage increases in response to their own cost pressures.
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Despite the strong premium rate increases, there has been little pressure on commission rates. This is due to the market power commanded by the larger broker networks. In context, commission rates account for ~70% of insurance brokers’ income.
Medium-Term Margin Targets Appear Achievable
In FY23, all divisions delivered growth in revenue and profitability. In particular, EBIT margin expansion was between 140 to 290 basis points.
In light of the operating leverage evident across the business portfolio, the Company has upgraded its medium-term margin targets across most divisions. The upgrade in medium-term targets reflects management’s confident that it can extract further efficiencies to drive margin growth.
While not specified, the ‘medium term’ timeframe likely refers to a 3-5 year period. Overall, we estimate that should AUB achieve its medium-term targets in FY25, there would be ~15% upside to consensus EBIT estimates.
Gearing Has Reduced Quicker Than Expected
Following an equity raising in May 2022, the Company ended the FY22 period with a net cash position of $211.5m. However, completion of the Tysers acquisition (partially though debt) means that the balance sheet is now in a net debt position. As at 30 June 2023, gearing (on a net debt to EBITDA basis) was 1.7x. However, this has declined from 2.6x as at 31 December 2022.
Importantly the balance sheet has de-geared much quicker than initially expected. At the time of the Tysers acquisition, gearing had been expected to decline to ~2.4x within 12 months of completion (in September 2022).
The lower gearing profile means that the Company remains well positioned to fund bolt-on acquisitions and pay dividends in the 50-70% payout range.
Notwithstanding the improvement in the share price since our recent report, AUB shares are still trading on a multiple which is at the bottom end of the trading range over the last three years. We do not consider the current multiple to be overly demanding in the context of:
i) An underlying EBIT growth profile of +12% over FY23-26 on a CAGR basis. Further, there is upside risk to EBIT estimates should AUB achieve its medium-term margin targets in FY25.
ii) Typically conservative Company guidance. To this end, it is worth noting that underlying NPAT in FY23 was ~2% ahead of consensus estimates and ~5.5% above the guidance issued in May 2023. This was achieved despite upgrading the latter guidance several times during the year.
iii) A deleveraged balance sheet that underpins the potential for EPS-accretive bolt-on M&A acquisition opportunities. Notably, unlisted acquisition multiples still at levels where they can be accretive.
AUB has been rising in a clear channel for the past 12 months. It is now at the lower end of that channel which provides investors right now with a lower risk entry point. We therefore expect AUB to recover from here back towards $32. A break under the August low of $26.81 would be a negative.
Michael Gable is managing director of Fairmont Equities.
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