Following a number of recent trading updates, we recently reviewed Steadfast Group (ASX:SDF). This was in order to assess the earnings outlook beyond FY20 due the expected impact on volumes arising from COVID-19.
About Steadfast Group
Steadfast Group has the largest general insurer broker network in Australia. It holds a market share of ~30%, as well as having a small footprint in NZ and Asia. The Company has a stable network of brokers that has grown as new brokers have joined the group. These are either individually or as part of an acquired group, Only a very small number of brokers have left. As at 31 December 2019, the Steadfast Network had 473 brokers having grown steadily from 278 brokers as at August 2013.
The key earnings driver for SDF is the broker network, which contributes the majority of overall Gross Written Premium (GWP). The Company also earns marketing and administration fees from its insurer partners. These are used as a revenue stream to provide products and services to the Steadfast broker network, as well as rebates to brokers. The bulk of the remaining GWP is generated from the Company’s Underwriting Agencies division, with SDF being the largest underwriting agency group in Australia.
Recent Trading Commentary Has Been Positive
Since the release of its interim results in February, SDF has provided monthly updates on its trading performance in light of COVID-19. The key message is that underlying revenue and earnings growth, in comparison to the prior corresponding period, have been maintained. The key factors supporting this include:
1. SDF is Well Diversified by Product Line
SDF’s highest exposure is to Strata and Machinery & Plant. These sectors are not expected to be materially impacted by COVID-19.
2. Premium Rates Continue to Increase
SDF reported continued premium rate increases in 1H20 (+6.5%) and commented at the time of the 1H20 results release that it expects the hardening phase of the insurance premium cycle will last at least another two years after large natural disaster losses.
Premium rates continue to rise and were up by 7.3% for the March 2020 quarter. In the most recent trading update, the Company commented that premium rate increases continued in May. Having said that, while rate increases remain strong, the economic slowdown may temper the level of rate increases in FY21.
3. Organic Growth Rates Remain Strong
Strong organic growth at the GWP level is expected to continue in 2H20 and into FY21 given the favourable premium rate environment. However, the rate of organic EBITA growth is likely to continue to be impacted by increased IT spend.
4. Gearing Level & Liquidity Position Have Been Maintained
SDF’s balance sheet is conservatively geared. Group gearing as at 31 March 2020 was 21.1% and in line with the 20.9% reported as at 31 December 2019. In a recent trading update, the Company has advised that there has been no adverse impacts on its strong working capital position. Further, debt expiry risk is minimal and the Company has enough debt capacity to absorb potential liquidity stress from premium deferrals.
SCTP Initiative Continues to Support Medium-Term Earnings
The Steadfast Client Trading Platform (SCTP) was launched in June 2016 and is exclusive to Steadfast Network brokers, their clients and participating insurers. As at 1H20, there were 470 active brokers now using the SCTP platform. The real value add for SDF is getting additional brokers to use SCTP in conjunction with a cloud-based broking platform called INSIGHT.
The SCTP seamlessly integrates with INSIGHT. Brokers using both INSIGHT and SCTP generate increased operating efficiency (as the systems are ‘integrated’) in comparison to brokers that use just the SCTP with an alternative to INSIGHT.
Having previously outlined a target to achieve $2.3b in GWP and EBITA of ~$23m from SCTP by FY23, SDF is no longer confirming previous financial targets from the SCTP. This is due to a revamp of the pricing structure that makes it more resilient to potential future regulatory scrutiny.
While the quantum of the contribution from SCTP is now less clear, the SCTP is still expected to be a source of medium-term upside risk to earnings, given that:
i. The take-up rate of INSIGHT is expected to improve, and
ii. Changes to the structure of SCTP pricing should flow through in the form of higher earnings from equity brokers. As SDF lifts its level of ownership of the network (e.g. as brokers retire or seek to access equity), it should indirectly capture more of this benefit.
SDF has been a prolific acquirer and the businesses acquired have been a significant contributor to earnings growth. The Company has spent on average ~$100m per annum over the last 4.5 years on acquiring subsidiaries.
The low gearing level, coupled with potential challenges for independent insurance brokers, provide the Company with the opportunity to either pursue further acquisitions or increase ownership interest within its existing broker network.
The current COVID-19 environment also provides the Company with an opportunity to acquire independent insurance brokers, who may face cash constraints from potential commission payment delays in light of insurers offering premium holidays.
While the share price has gained ground since our last report in The Dynamic Investor, we remain attracted to SDF’s fundamentals. In particular, SDF has a highly defensive earnings stream, high cashflow generation, and strong balance sheet.
There is upside risk to earnings growth from FY21 from a range of avenues. These are: i) Further benefits from the SCTP initiative, ii) Still-attractive organic GWP growth rates underpinned by strong premium rate increases, which are expected to last for a further 18-24 months and iii) The potential for future acquisitions of small brokers, which are likely to be on accretive terms.
SDF bottomed out later than other stocks, hitting a low in April instead of March. However, it has been trending well since then. During the last month though, it has been consolidating the prior uptrend in the form of an ascending triangle (blue lines). This means that it is getting ready to head higher again. If we see a clear break to the upside (a close above $3.45), then that would be the next buy signal and SDF would then be on course to head into the high $3’s.
Michael Gable is managing director of Fairmont Equities.
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