Steadfast Group (ASX:SDF) has the largest general insurer broker network in Australia, with a 28% market share. It also has a small footprint in NZ and Asia. The key earnings driver for Steadfast Group is the broker network. That generates $5b in Gross Written Premium (GWP), over 85% of the group total. The Company earns marketing and administration fees from its insurer partners. These are used as a revenue stream to provide products and services to the Steadfast network, as well as rebates to brokers. Steadfast Group is also the largest underwriting agency group in Australia, with its Underwriting Agencies division generating the bulk of the remaining GWP.
Investment In Technology
SDF is going through a phase of increased spending on its existing technology platform in order to deliver future earnings growth (as a result of increased commissions paid to Steadfast Network brokers using the SCTP) and broker efficiency. Investment in key technology platforms enables the Company to access and control data which flows between clients, brokers and insurers. A key area of focus is the Steadfast Client Trading Platform (SCTP). This was launched in June 2016 and is exclusive to Steadfast Network brokers, their clients and participating insurers and seamlessly integrates with the Company’s own cloud-based broking platform.
To date, SDF has contracts with insurer partners on five insurance lines, with a full rollout of these expected in early 2019. Revenue from the SCTP will commence in FY18 with growth into FY19 and FY20, as activity increases for additional insurers across product lines.
Scope for Further Acquisitions
Steadfast Group has flagged a strong existing acquisition pipeline of businesses that are existing members of the SDF Network and has sufficient balance sheet to fund further acquisitions via debt. The significance of future acquisitions is that the utilisation of the SCTP by businesses acquired by SDF has the potential to increase the earnings contribution from these acquisitions.
Is Steadfast Group Attractive at Current Levels?
We consider Steadfast Group to be an attractive medium-term investment. However the current investment undertaken by the Company regarding technology is impacting profitability in the short term. Further, increases in premium rates (to which insurance brokers are directly leveraged) in the recent interim results were softer-than-expected.
Since we last covered the stock in late December (Not getting the research? Sign up now to a free trial), the 1-year forward P/E multiple has retraced from ~23x to ~20x. This suggests to us that the market is taking a more cautious approach to factoring in an uplift in earnings from the SCTP initiatives as well as further EPS-accretive acquisitions.
The contribution to profit in FY19/20 from SCTP initiatives means that the earnings growth profile is likely to be less reliant on the pricing cycle for premium rates. However, as Steadfast Group has not yet provided a clear insight into exactly how much revenue/earnings upside these initiatives are expected to deliver, it is difficult to factor these into forecasts for FY19.
Notwithstanding, the current multiple is not at an attractive enough level to spike our interest. The key risk for the stock is that because earnings growth forecasts for FY18 and FY19 are a significant step-up from the 9.9% growth reported in FY17, this leaves little room for error in the event that:
i) Technology roll-out costs are higher than expected and/or
ii) The revenue benefits from the roll-out is below expectations.
The Steadfast Group chart
The chart also is looking negative here, indicating that there is more downside to be expected. The peak in December formed an evening star reversal on the weekly chart (circled), which is a classic sign of a top. They then broke down from support in February before retesting that support line and failing again. It looks as though Steadfast Group is going to keep heading lower from here and we would need to see it establish a new support level before we are comfortable from a charting perspective.
Michael Gable is managing director of Fairmont Equities.
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