Equity Strategy
22 November 2023
Insurance > Banks
Trimming Banks to Add Insurance Exposure

After a lacklustre set of results from the banks, the portfolio is moving further underweight the banks by trimming National Australian Bank (NAB) by 2%, reducing our banks weighting to 15.5%, vs the ASX 300 weighting of ~19.5%.

The portfolio is adding Steadfast Group (SDF) at 2%, to increase our weighting in the insurance sector, which unlike the banks has cyclical tailwinds over the next 12-24 months, while adding exposure to an earnings compounder in SDF.


Banks Reporting Wrap – Earnings Officially Peaked

The recent banks reporting of NAB, ANZ and Westpac confirmed our view that banks earnings have peaked this cycle. The results did not point to a promising outlook for earnings growth over the next 12-24 months.

The key points from banks reporting season 

  1. Competition still intense for mortgages and deposits
    All big 4 banks called out thinning net interest margins (NIMs) in the recent results. Competition should remain fierce over the next 6-12 months, which will be a headwind for banks’ margins and earnings. 
  2. Bad debts not a problem, yet
    Bad debts can only continue to rise from here. However, Australian households remain resilient with lower-than-expected bad debts over the last period. The real test comes over the next 12 months, with rates likely to stay elevated and household savings depleted.
  3. Costs are rising
    The cost to income ratios of the banks are continuing to rise. Cost inflation is another risk driven by higher staff, occupancy and technology costs. The current inflationary environment is leading to higher wages and higher rents for the banks. There is a risk these costs catch the market off guard in the next 12 months.

ANZ is still the portfolio’s largest (positive) active position in the banks. The investment thesis on ANZ:

The portfolio is positioned to the banks with more valuation upside. ANZ’s valuation (price/book) is too cheap relative to its profitability (return on equity).

Continued diversification benefits from ANZ's business mix, mitigating headwinds in Australian retail banking. 

ANZ has the most capital to return to shareholders of the big 4 banks, even if the $4.9bn Suncorp bank deal goes through. This should support earnings via buybacks over the next 12 months. 

Retail banks (Commonwealth Bank of Australia/Westpac Banking Corp) are expected to have the most significant headwinds in the next 12 months. 

Trimming NAB by 2% (Portfolio weight of 4.5%)

NAB is trimmed to neutral as the stock is trading at its 10-year average price-to-book. NAB’s profitability looks challenged with return on equity (ROE) contracting 170 basis points (bps) during 2H23 (13.7% to 12%), with evidence of rising competition in small to medium enterprise (SME) business banking and higher funding costs (with a larger wholesale funding mix). 


Steadfast Growth - Adding SDF at 2%

Steadfast (SDF) is an Australia-based insurance brokerage network. Steadfast acts as an intermediary between insurance companies and clients, providing a range of services to support its network of insurance brokers across Australia and New Zealand.

SDF is one of the largest insurance brokers in Australia. There are currently 426 brokers in the Steadfast Network, enjoying the benefits of the Steadfast brand, purchasing power, IT systems, marketing and back office support. 

Figure 1: SDF is the biggest broker network in the Intermediated Australian Market ($35bn); AUB (AUB) is the closest competitor with ~15% of the market

Steadfast also selectively purchases equity stakes ranging from 25% to 100% in brokers within the Steadfast Network. Steadfast has a stake in 68 brokers of the network (~16%), which collectively account for 48% of the gross written premiums (GWP) of the business. This generates cost synergies for SDF and provides greater exposure to high performing brokers.

Figure 2: SDF has compounded earnings growth over the past 5 years; consensus looks conservative from FY25 onwards

SDF has also built a strong underwriting agency business over the past 10 years, growing from effectively zero in FY14 to generating $169.5m in earnings before interest, tax and amortization (EBITA) in FY23 (~40% of EBITA) with a build and buy strategy. This segment complements the existing broker network.

How will SDF Grow?

There are 3 key ways SDF can continue to grow earnings over the medium term, and importantly above consensus expectations:

  • Organic growth – SDF brokers and underwriters generate higher fees from higher insurance premiums. Premium growth is currently supported by the hardening insurance cycle.
  • Inorganic growth – SDF has a stellar track record of acquiring and integrating broker networks and underwriting agencies into the business.
  • Margin expansion – Scale, technology and higher fees should drive earnings growth over the medium term.
Figure 3: Growth has been a mix of organic and inorganic growth over the last 5 years

Organic Growth – Hardening Insurance Cycle to Support Growth

A rising insurance cycle with increased premiums directly benefits SDF's earnings by generating higher commissions through the broker network and higher fees in the underwriting business.

Premium rates have increased substantially the past few years, but this trend has been ongoing for the past decade, with the current trend set to persist. The ongoing hardening cycle is fuelled by insurers passing on higher costs from claims and reinsurance, particularly due to increased risks from COVID and catastrophe repricing. We anticipate premiums to exceed the trend in the medium term, providing a favourable environment for SDF's earnings.

Figure 4: Insurance gross written premiums (GWP) are trending higher in Australia, benefitting SDF
Figure 5: GWP growth looks conservative in a backdrop of a hardening insurance cycle and potential merger and acquisition (M&A)

Inorganic Growth – Accretive Acquisitions, US Option

Domestic M&A

SDF has a strong track record of acquiring and integrating businesses into their network. This has added GWP to the business, increasing the scale and pricing power of SDF’s network, while generating cost synergies. SDF has also leaned on earnings multiple arbitrage as a principal means of generating shareholder value.

SDF are still actively looking for further acquisitions in the future. This should provide further earnings per share (EPS) growth over the medium term.

Figure 6: SDF has a proven track record of successfully completing earnings accretive acquisitions; we expect more to come over the next 12-24 months

Offshore growth

SDF are looking to replicate their domestic success offshore. In October, aligning with its expansion strategy in the United States, SDF successfully acquired the ISU Group (ISU) for a sum of US$55 million. ISU, a substantial independent insurance agency network, consists of ~220 members and underwrites around US$6bn in GWP across ~40 states in the US.

There is a long runway for growth in the US and overseas, as SDF capitalises on the current offshore network, holding a 60% stake in UnisonSteadfast (US$30bn of GWP) and through the recent acquisition of ISU. We expect further offshore acquisitions in the future and organic growth as the roll-out of SDF’s leading technology platform and increasing scale attracts more brokers to the offshore network. 

The US growth angle is not reflected in consensus, so investors today get effectively a “free option” on US expansion over the medium term. 

Figure 7: There is a long runway for growth in the US

Margin Expansion - Scale and Technology

  • Operating leverage - Margins should expand as SDF continues to scale.
  • “Hubbing” – SDF combines the business support functions of brokers it has a controlling stake in to generate cost synergies. SDF calls this “Hubbing”. 
  • TechCo – SDF technology automates large portions of the processes traditionally performed manually. The rollout of this technology to the network should drive higher margins through a reduction in operating costs and higher franchise fees from the network. 
Figure 8: Margin expansion from operating leverage, Hubbing and TechCo are not within consensus

Valuation Attractive

SDF looks cheap relative to our expected growth over the medium term. We expect double digit growth over the next few years and SDF currently trades on a price-to-earnings ratio (PE) of ~20x. The current PE is also 1 standard deviation below its 5-year average, again indicating attractive value. 

Figure 9: SDF’s PE is attractive vs its 5-year average

NAB (NAB) – Trimming 2%

Stock profile: Cyclical, domestic bank

Investment thesis: growing quality, high quality management, ROE improving, #1 business banking.

Valuation upside: low single digit (3-5%)

Earnings growth compound annual growth rate (CAGR) (FY24-FY26) (consensus): 4%

Earnings upside: negligible


Steadfast (SDF) – Adding 2%

Stock profile: Defensive compounder, dominant market position

Investment thesis: Strong insurance premium cycle, roll up story in a fragmented industry, option on US expansion, valuation attractive 

Valuation upside: low double digit (10-15%)

Earnings growth CAGR (FY24-FY26) (consensus): 7%

Earnings upside potential: high single digit (6-9%)

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Written by

Rob Crookston, Equity Strategist

Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.

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