Is it time to buy Austbrokers Holdings Limited?

Austbrokers Holdings Limited (ASX:AUB) is against trading near its 52-week lows. Is now the time to snap up this high quality company at a bargain?

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Insurance broker Austbrokers Holdings Limited (ASX: AUB) fell heavily in January after issuing a profit downgrade as rates on commercial insurance have fallen by more than 10%, with further pressure expected for 2015. This pushed the stock to a 52-week low of $8.21, which is close to where the stock is now trading.

Is this a second chance to snap up this high-quality business at a bargain?

Austbrokers operates a network of insurance brokers under its 'equity ownership model', meaning they hold at least 50% ownership of brokerages within their network. The network generated over $2 billion gross written premium (GWP) and contributed to 82% of total revenues in FY14. Given that commercial insurance accounts for the vast majority of this premium (>70%), it's no surprise that the market is very concerned with future profitability.

One of the main reasons commercial insurance rates have been falling is because reinsurance rates have also been falling. The lack of natural disasters over the past few years has meant that claims are running below average, boosting reinsurance capacity by increasing the amount of capital they have to deploy.

The excess capacity is compounded by the fact that interest rates have been low globally, so assets managers and financial institutions have started directing funds to higher-yielding catastrophe bonds issued by reinsurers over more traditional asset classes.

Whilst lower reinsurance rates are predicted to persist in the short to medium term, I believe it is unlikely to be the norm in the long run.

For a start global interest rates will one day normalise as economies around the world begin to recover. Also recent M&A activity in the reinsurance industry will provide them bargaining power over insurers, potentially halting the slide in reinsurance rates. Most important of all however, is that natural disasters are bound to occur and could strike in quick succession (just think of the number of airline disasters we've had of late), which could quickly drain excess capacity.

Whilst falling commercial rates might be cyclical, insurance brokers potentially have a structural issue to deal with. Aggregator sites and bancassurance have largely taken away personal insurance from brokers, leaving them with commercial insurance. However Deloitte believes that in the medium term that brokers' stronghold on commercial insurance could change, estimating that over 50% of SMEs would be open to purchasing insurance online.

Over a decade ago travel agents stared at a similar future, and whilst the number of travel agents have shrunk those that remain have become more profitable. The key to their survival was switching their focus to selling expertise, rather than just be an intermediary in a commoditised product.

Austbrokers appear well aware of this threat and have already started carving its niche by providing risk advisory services. The acquisition of a 60% stake in Altius Group Pty Ltd in January helps the company become the leading provider of risk services to companies in Australia.

What to do?

Austbrokers has managed to notch up nine consecutive years of double-digit earnings growth, and falling commercial rates are likely to be a cyclical issue in the long run. Further a dividend yield of 4.6% is attractive in the current climate, especially factoring in the fact that this only represents a payout ratio of 60% – making it safer than blue chip yield stocks like Woolworths Limited (ASX: WOW).

However whilst the company has a strategy in place to combat the structural issue it faces, the fix is still in its infancy and will take a few years to generate good cross sell opportunities. Moreover the short term dynamics of reinsurances rates could open up investors to further share price falls.

I would say that Austbrokers is a speculative buy and should at least be on your watchlist. However there are better opportunities available at the moment, like this sexy stock that our analysts at Motley Fool have just identified.

Motley Fool contributor Simon Chan has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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