Austbrokers Holdings Limited (ASX: AUB) operates a network of insurance brokers, underwriting agencies and risk management services. At the core of the company are 50 insurance brokers in more than 175 locations across Australia and New Zealand, making it one of the largest companies of its kind in the region.
The smaller underwriting agency business consists of 21 agency groups with more than 50 specialist product lines ranging from bus to farm insurance. Whilst a broker sells existing insurance, an underwriting agency has the power to write premiums on behalf of insurers. Neither a broker nor an underwriting agency is responsible for paying out claims.
The risk services business was launched last year, and offers advice and consultancy on risk management. It already has an impressive client list including Bunnings, DHL and Leighton Holdings Limited (ASX: LEI), and the business generated $700,000 in profit in its first year of operation.
A winning business model
Austbrokers pursues different growth strategies in each of its three components. It aims to acquire small independent insurance brokers, holding an equity stake of at least 50% in each business, but leaves operations in the hands of the original owners. This strategy ensures that the acquired businesses retain a strong local connection whilst benefiting from the support of a larger organisation. For example, Austbroker's iClose placements platform, a software tool available to all members, enables brokers to generate multiple insurance quotes from a single request.
With the agency business, management identifies niche insurance market segments that it believes it can dominate, and then either buys an incumbent firm or starts a new one. There is also a focus on recruiting experienced people to run these agencies, and the average consultant has at least 30 years' relevant experience.
The recently established risk services business aims to develop a broad range of complementary insurance services that the broker network can offer its clients.
The three divisions of Austbrokers are highly complementary:
- Significant opportunities exist to cross-sell products. For example, brokers can sell products written by agencies and the risk services business can refer work to the brokers.
- Services can be shared across the group. For example Austbrokers has invested heavily in IT, and common systems are available to its members. Many processes are automated and data generated across the group is collected and analysed to identify best practice.
- Whilst the insurance brokerage business follows cyclical fluctuations in the insurance industry, the other divisions have more stable levels of profitability ensuring greater earnings consistency at the group level.
Weaknesses
Insurance is a cyclical industry and it seems that a downward trend is just beginning. On 23 January the company announced that the weakening conditions experienced towards the end of the last financial year have continued into the first half of this year. In particular, lower premium rates have led to reduced commissions for Austbrokers. Consequently earnings are likely to be up by less than 5% on last year. This should not worry investors with a longer-term view as rates will eventually return to their former levels.
Austbrokers is heavily dependent on the economic health of small and medium sized enterprises (SMEs), which make up the majority of its customer base. Even if conditions remain strong, online comparison sites such as iSelect Limited (ASX: ISU) may pose a threat should they enter the SME market. However this is unlikely given business insurance is more complicated than personal insurance and therefore harder to sell over the internet.
A golden buying opportunity?
The market appears to have overreacted to the recent earnings downgrade and the share price has fallen by more than 17%. At current prices, the market capitalisation of Austbrokers is less than 15 times last year's earnings and it has a dividend yield of 4.6%.
This is decent value for a company that has grown earnings per share by an average of 14% annually over the past four years. In comparison, competitor Steadfast Group Limited (ASX: SDF), which listed in August 2013, offers a dividend yield of only 3.2% and has yet to establish such an impressive earnings record.
