Intact Financial Corporation – Building a Leading P&C Insurer

    • Intact Financial Corporation, traded on the TSX in Canada, is Canada’s largest Property & Casualty (P&C) insurer when measured by net premiums written.
    • IFC is scheduled to complete the acquisition of RSA Insurance Group Plc.’s Canadian, UK and International entities for ~$5.2B in Q2 2021.
    • IFC recently reported Q4 and FY2020 results and provided an update on its impending acquisition.
    • IFC’s long-term debt-to-total capital ratio will rise from 24.1% as at FY2020 to ~26% following the acquisition but should drop to the company’s 20% target level within 36 months.
    • While IFC is currently fully valued based on FY2020 earnings, investors need to account for the growth that should materialize from the impending RSA acquisition. On this basis shares are reasonably valued.

    NOTE: The Canadian dollar is the currency reflected in this article.

    Introduction

    In December 2004, ING Canada Inc. completed its IPO (initial public offering) and in January 2007 I initiated a position in ING Canada Inc.; the company subsequently changed its name in 2009 to Intact Financial Corporation (IFC.to) with shares being listed on the Toronto Stock Exchange (TSX).

    Over the years I have periodically acquired additional shares and for the sake of full disclosure I currently hold shares in accounts I include in the FFJ Portfolio and also in accounts for which I do not disclose details for confidentiality reasons. A reasonably recent article in which I disclosed the purchase of additional shares can be found here.

    In addition, I am helping investors in their early/mid 20s create their own respective investment portfolios. Each portfolio holds shares in high quality companies and IFC is included in their respective portfolios. In July 2020 I disclosed one of their purchases in this article.

    Business Overview

    I highly encourage readers unfamiliar with IFC to learn about the evolution of the company here.

    IFC’s products and services are available through various brands for which information about them can be found here. I also encourage readers not to overlook Intact Investment Management and Intact Ventures.

    A comprehensive Investor Presentation is also available for review here.

    Acquisition of RSA Insurance’s Canadian, UK and International entities

    IFC’s international expansion continues with the November 18, 2020 announcement of its intent to acquire RSA Insurance Group Plc.’s Canadian, UK and International entities for ~$5.2B. A high level overview of the acquisition financing can be found in the Press Release and further details can be found in the Presentation which accompanied the Press Release.

    IFC is Canada’s largest Property & Casualty (P&C) insurer when measured by net premiums written with 15.3% of the total Canadian P&C insurance market in 2019; RSA ranked 7th in overall market share at 4.4%.

    The acquisition of RSA’s Canadian, U.K., and international operations is expected to increase IFC’s annual premiums from $12B to $20B and will increase IFC’s premiums in Canada and its total premiums in specialty lines by ~30%; IFC’s net premiums written grew ~10% from $10.57B in 2019 to ~$11.62B in 2020.

    As at FYE2020, IFC’s debt-to-total capital ratio (leverage ratio) had increased to 24.1% after issuing $0.6B of medium-term notes in December 2020 to partially fund the RSA Acquisition, representing an impact of 3.8 points on the leverage ratio, and another $0.3B earlier in 2020.

    IFC’s long-term debt-to-total capital ratio target is 20%. Senior management has indicated the leverage ratio is expected to increase to ~26% following the acquisition but should drop to 20% within 36 months. This transaction and its planned financing structure are not expected to lead to a change in the current credit ratings.

    On February 9, 2021 when Q4 and FY2020 results were released, management indicated IFC continues to expect this acquisition to close in Q2 2021 (April – June) and that in excess of $0.25B of pre-tax annual run-rate synergies can be expected within 36 months of the RSA deal closing.

    Q4 and FY2020 Financial Results

    IFC’s Q4 and FY2020 reports and filings can be found here.

    As at FYE2020, IFC had a total capital margin of $2.7B and a Minimum Capital Test (MCT) in Canada of ~224%.

    The MCT for Federally Regulated P&C Insurance Companies is a ratio expressed as a percentage and is calculated by dividing the P&C insurer’s capital available by minimum capital required.

    Federally regulated P&C insurers in Canada are required, at a minimum, to maintain a MCT ratio of 100%. The Office of the Superintendent of Financial Institutions (OSFI) has established an industry-wide supervisory target capital ratio (supervisory target) of 150% that provides a cushion above the minimum requirement and facilitates OSFI’s early intervention process. The supervisory target provides additional capacity to absorb unexpected losses and addresses capital needs through on-going market access.

    Once the RSA acquisition has been completed, IFC’s estimated capital margin is expected to be above $1.7B and the MCT above 194% in Canada, a Solvency II coverage ratio above 160% in the UK, and an RBC ratio above 400% in the U.S. All ratios are expected to exceed minimum guidelines and are expected to strengthen over time.

    Investors should also look at an insurance company’s combined ratio. The combined ratio is typically expressed as a percentage with a ratio below 100% indicating the company is making an underwriting profit with a ratio above 100% meaning it is paying out more money in claims that it is receiving from premiums.

    IFC performed well in this regard in that it reported an 85.6% combined ratio for FY2020 which included $74 million of catastrophe (CAT) losses, with $23 million related to COVID-19.

    Credit Ratings

    It is important to look at the risk aspect of an investment and not just the potential return. I, therefore, look at the ratings the major ratings agencies have assigned to a company’s long-term unsecured debt. I then take into consideration that as a common shareholder my risk is greater than that of bondholders. If a company’s unsecured debt is rated non-investment grade then I really need to consider the probability that my investment could be permanently impaired if the company’s financial condition deteriorates.

    I look at the ratings assigned to IFC’s Senior Unsecured Debt; I primarily rely on the ratings assigned by the major ratings agencies (Moody’s, S&P Global, and Fitch).

    Moody’s has assigned a Baa1 rating which is the top tier of the lower medium grade.

    Fitch has assigned an A- rating which is the bottom tier of the upper medium grade and is 1 notch higher than Moody’s rating.

    Both ratings are investment grade and are acceptable for my purposes.

    S&P Global does not cover IFC.

    Dividend, Dividend Yield, and Shares Outstanding

    IFC’s dividend history can be accessed here. We see that IFC has recently declared its 5th consecutive $0.83 quarterly dividend payable March 31st to shareholders of record on March 15th.

    Some investors may be disappointed that IFC’s track record of increasing its quarterly dividend after 4 consecutive quarters at the same level has been interrupted. In my opinion, this should not be cause for alarm. As noted earlier in this article, IFC’s acquisition of RSA Insurance’s Canadian, UK and International operations is going to increase IFC’s leverage to its highest level in over a decade and 6% above the 20% target. Reducing the leverage ratio is most likely of far greater importance to the Board and senior management than raising the quarterly dividend. I envision the $0.83 dividend will remain in place for FY2021 after which time it may be raised slightly depending on how the integration of the acquired entities is proceeding.

    With shares currently trading at ~$150, the $3.32 annual dividend provides investors with a ~2.2% yield. Depending on your investment goals and objectives this yield may/may not meet your requirements.

    Personally, the low dividend yield is not dissuading me from investing in IFC. I look at an investment’s overall potential return. In the case of IFC I expect the majority of my long-term return will be by way of capital appreciation.

    The weighted-average number of common shares outstanding (in millions) has increased as follows in the 2011 – 2020 timeframe: 115, 131, 132, 132, 132, 131, 133, 139, 140, and 143. This increase is the result of IFC issuing additional shares to assist with previous acquisitions. This share count is expected to increase as IFC will be issuing equity to assist with the financing of the RSA acquisition.

    Valuation

    IFC reported $7.20 in diluted EPS in FY2020. On the basis of the current ~$150 share price we get a PE of ~20.8. Looking at one of my sources of data I see 2011 – 2019 PE ratios of 15.86, 14.96, 18.50, 16.64, 16.86, 23.1, 19.41, 20.97, and 27.43.

    Management has not provided FY2021 guidance but has indicated in the Q4 and FY2020 Earnings Release that the average EPS estimate and Net Operating Income per share for Q1 among the analysts who follow IFC is $1.92 and $2.35, respectively.

    I am reasonably confident the RSA acquisition will be completed in Q2 2021 and after having reviewed the data I think FY2021 adjusted diluted EPS of $9.00 – $9.30 is not completely out of the realm of possibility. Using this range and the current ~$150 share price I get a forward adjusted diluted PE range of ~16.1 – 16.7.

    Determining IFC’s valuation is certainly not an exact science. Based on management’s track record over the ~14 years in which I have been a shareholder, I have found that IFC typically meets or exceeds earnings expectations.

    I do not view IFC’s valuation to be exceedingly rich and am reasonably confident that the company will be far more valuable than presently once the integration of RSA and the 2017 and 2019 acquisitions have been completed. I also have utmost confidence that within 36 months IFC will be able to reduce its 26% long-term debt-to-total capital ratio after the RSA acquisition has been completed to within the 20% target.

    Final Thoughts

    My investment decisions are based on the premise that I am a part business owner and I intend to remain a part business owner for the long-term. This is demonstrated by my ownership stake in IFC for the last ~14 years and my periodic additions to my exposure.

    I am confident management is making the appropriate strategic decision to expand internationally and fully expect the company’s leverage ratio to be reduced to the 20% target level within 3 years. I also expect that dividend increases will very likely resume in 2022 by which time IFC will have had an opportunity to derive some of the benefits from the RSA acquisition which is expected to close in Q2 2021.

    I view IFC as just slightly overvalued but the degree of overvaluation is not sufficient to dissuade me from acquiring additional shares at the current level.

    I wish you much success on your journey to financial freedom.

    Thanks for reading!

    Author bio: I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 33 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.

     I disclose our holdings which are held in the FFJ Portfolio and the dividend income generated from these holdings but for confidentiality reasons do not disclose details of holdings held in various tax advantaged accounts. 

     Disclaimer: I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article. I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

    Disclosure: I am long TSX: IFC.

     

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