After reporting full year results that were ahead of consensus estimates, we assess the prospects for further upside in the share price of Genworth Mortgage Insurance (ASX:GMA). We also examine the extent to which GMA can remain an attractive yield play, along with how the chart looks.
The Company is the leading provider of Lenders Mortgage Insurance (LMI) in the Australian residential mortgage lending market. It has an estimated market share of approximately 31% of the Australian high loan-to-value ratio mortgage origination market, on the basis of New Insurance Written (NIW). In Australia, LMI facilitates residential mortgage lending by transferring risk from lenders (i.e. banks and other financial institutions) to LMI providers. LMI is usually taken out in loans with a loan-to-valuation ratio (LVR) above 80%. The Company’s major shareholder is Genworth Financial, who holds approximately 52% of GMA’s issued shares.
Key Fundamental Drivers
Improvement in Key Metrics
Net Earned Premium (NEP) Growth in Excess of Guidance
NEP is defined as the gross premium written (i.e. gross revenue) less re-insurance expenses.
NEP increased by 6.0% and was above the Company’s NEP growth guidance of -5% to +5% for FY19. The stronger-than-expected performance was due to policy cancellation initiatives. It was above market growth by some of GMA’s lender customers. They also had traction with a number of strategic initiatives that have led to increased flow-through of gross premium.
The Company has left NEP growth guidance unchanged for FY20. However, we consider that there is potential for NEP to exceed the upper end of this guidance range. This is given that momentum from the stronger-than-expected GWP growth reported in 2H19 is likely to continue into FY20.
Cost Growth Well Contained
The better-than expected profit result was achieved despite an increase in the Expense Ratio, to 35.9% in 2H19, from 34.7% in 1H19. Overall, cost growth was well contained in the context of strong GWP growth.
Improvement in Delinquency Rates
A delinquent loan is one that has been in arrears for three or more months. The delinquency rate is the portion of delinquent loans relative to the total number of policies.
The Delinquency Rate as at 31 December 2019 was 0.56%. It has declined over the course of the second half of the year. The improvement was due to: i) Faster processing by some lenders, as well as ii) Stable cure rates (i.e. the portion of bad loans that reverse) over the course of 2H19, following a period of softening cure rates since 2018.
Overall, the delinquency rate for FY20 is likely to be maintained at the FY19 level, as the recovery in housing prices continues. In addition, the unemployment rate (which is another key driver of delinquency rates) remains low and below 10-year average.
Contract Renewals Have Reduced Revenue Risk
The Company has commercial relationships with over 100 lender customers across Australia. Around 75% of GWP is generated from only three lender customers. Given the concentrated nature of this exposure, the loss of a major customer is a major risk for GMA. This is evidenced by the loss of the contract with Westpac in February 2015.
GMA has since been successful in renewing existing relationships and has not lost any further contracts. Recently, the Company renewed it contract with Commonwealth Bank for a further three years to 31 December 2022. This contract represented 53% of GWP in 1H19.
Excess Capital Supports Future Special Dividends
Given its capital position has remained well above the Company’s target range in recent years, GMA has undertaken significant capital management activities. These include on-market share buybacks and special dividend payments.
Commentary in the FY19 results release indicated that the Company intends to continue with further capital management initiatives in light of the excess capital position and low gearing level (13.1% as at 31 December 2019 on a debt/equity basis). To this end, we estimate that GMA has excess capital equivalent to $1.00 per share. This could fund special dividend payments in 2H20 and 1H21, in addition to the usual dividend payments.
GMA is presently trading on a 1-year forward P/E multiple of 17x, which is towards the upper end of the range over the last two years. Another measure that can be used to assess an appropriate entry point is the discount/premium to NTA. Following the results release, the shares traded on a premium of ~5% to NTA (~$3.66 per share as at 31 December 2019).
Typically, the shares have traded at a 20-40% discount to NTA. However, in light of the improved fundamentals – in particular the stronger NEP growth outlook and the potential use of excess capital in the form of special dividends payments – we consider that any weakness in the share price below NTA would present a more attractive entry point.
Further, it is worth noting that short interest in GMA shares (which is normally one of the highest among ASX-listed Insurers and diversified financial stocks) provides some level of support in the event of further weakness. According to daily short positions reported by ASIC, the level of short interest has fallen from 10.9% as at 29 January 2020 to 8.8% as at 13 February 2020.
GMA staged a very strong recovery in 2019 which saw it push past its 2015 peak and make new all-time highs. At the moment it seems to be consolidating above the 2015 peak, which is a positive. On the negative side though is the fact that it tried to make a new high in early February, but that was rejected. At the moment GMA is retesting support near $3.60. It needs to hold that for the chart to look positive, otherwise it may well fall away further, providing a better entry point.
Michael Gable is managing director of Fairmont Equities.
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