We recently researched AUB Group (ASX:AUB) in The Dynamic Investor as the shares appeared oversold. This was despite no material change in the fundamentals and the market seemingly not fully factoring in growth opportunities from a recent acquisition. With the shares having re-rated strongly since our report, is there still value at current levels?
About AUB Group
AUB Group 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) and has ~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 four segments, with Insurance Broking (Australia) the main contributor to group profit. The other operating divisions include BizCover, Insurance Broking (NZ) – after the Company entered the NZ market in early 2015 – and Underwriting Agencies.
Key Fundamental Drivers
Premium Rate Environment Remains Favourable for Australian Broking
The Australia Broking division has exhibited operative leverage in recent periods. Underlying EBIT margin has expanded from 27.8% in FY20, to 13.2% in FY21 and 33.7% in FY22. The improvement in underlying EBIT margin over this period has been underpinned by cost reductions. These are due to network rationalisations, which have resulted in a reduction in the number of operating businesses. This in turn has helped to improve underperforming businesses, and creating scale benefits.
The current operating environment for the Australian Broking remains attractive, with the tailwind of premium rate increases continuing. It is estimated that premium rate increases for 1Q23 were +6.6%, with premium rate increases >5% in each of the past six quarters.
In terms of the outlook, the combination of cost inflation, claims frequency and increased sum insured are expected to continue to support premium rate increases of ~6% or higher over the next 12 months. Continued benefits from network optimisation, coupled with ongoing strength in premium rates is expected to support further EBIT margin expansion in FY23.
Strong Track Record of Acquisitions
The Company’s most recent acquisition – BizCover – acquired in February 2020, is performing well and there is significant growth potential for the business. BizCover, which is the leading online small business insurance service provider in Australia, generates significantly higher margin that the broader Australian Broking business. EBIT margin for BizCover expanded by 150 basis points to 37.8% in FY22. This was underpinned by: i) Strong growth in direct channels (+27%) and ii) Intermediated channel growth, particularly with White Label partners, and growth in other markets proving to be slower than planned.
BizCover’s value proposition remains strong as a genuine alternative to intermediated markets for micro-SME clients. While BizCover is the market leader in the micro-SME market, its market share is small. To this end, AUB have identified a sizeable target market in the micro-SME segment. They intend to grow the business further, by rolling out new products and entering new geographies. There will be an increased focus on investment for intermediated channels.
More recently, the Company completed the acquisition of Tysers, a Lloyd’s wholesale broker. This was partly funded by an $350m equity raising. Tysers is a leading London-based specialist international insurance broker (6th largest Lloyd’s marketplace wholesale broker). One of the key attractions of the acquisition is that ongoing annual synergies assume AUB redirects A$200m of GWP to Tysers post-acquisition. AUB estimates it will have additional capacity of A$500-600m to place through Tysers over the medium term.
AUB expect the Tysers acquisition to be 30% EPS accretive on a pro forma 2022 calendar year basis (including synergies).
Gearing Level Expected to Reduce Due to Strong Cash Generation
Post the equity raising in May 2022, the Company ended the FY22 period with a strong net cash position. However, this is only temporary, as the equity raising was used to fund the Tysers acquisition. AUB has stated that the gearing level is expected to reduce from 2.8x to around 2.4x within 12 months of completion of the Tysers acquisition. The maximum gearing target is 3.0x.
Following the Tysers acquisition, the Company remains strongly placed to fund bolt-on acquisitions and pay dividends in the 50-70% payout range, due to organic cash generation (cash conversion of >100% over FY21 and FY22) and debt headroom. Regarding potential acquisitions, the Company is likely to target bolt-on acquisitions that deliver synergy benefits or to expand capabilities and footprint.
Following the recent re-rating in the shares, AUB is currently trading on a 1-year forward P/E multiple of ~19x, which we still do not consider demanding in the context of an underlying EBIT growth profile of +16% over FY22-25 on a CAGR basis. Notwithstanding the ongoing challenges in NZ Broking division, the outlook for premium rates remains the key valuation driver for AUB given that it pertains to the Australian Broking division (which accounts for ~80% of group EBIT).
We see potential for a re-rating in the shares from current levels from: i) Ongoing EPS-accretive acquisition opportunities within and outside its network have the potential to drive a further re-rating in the shares and ii) Growth opportunities from the successful integration of the Tysers acquisition, which appear to be only partially factored into current consensus estimates.
In mid-August. AUB broke the downtrend and rallied to over $22. After that, it eased back to retest the downtrend line before bouncing up off it solidly in early October. The last couple of weeks has seen the range tighten up here before breaking out again for another move. We therefore expect the shares to continue higher from here.
Michael Gable is managing director of Fairmont Equities.
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