Canada's property and casualty insurers have had a tough time on markets this year, but for BMO Capital analyst John Reucassel, the outlook is attractive, particularly for industry players, ING Canada Inc. [IIC.TO] and Northbridge Financial Corp. (OTC:NBFCF).
Mr. Reucassel said in a note to clients:
The two main reasons that ING Canada and Northbridge make relatively attractive investments are "hard" book values and the potential for premium growth in 2009.
Mr. Reucassel has "outperform" ratings on both Northbridge and ING Canada, with respective price targets of C$38 and C$43. ING is down 39% year-to-date, while Northbridge has tumbled 16%.
Kingsway Financial Services Inc. (NYSE:KFS), another Canadian P&C insurer is rated "market perform" by Mr. Reucassel with a C$9 price target.
Shares in Kingsway have fallen as much as 70% over the past 52 weeks and the company, derailed by higher claims revisions and credit rating downgrades, is now undergoing a sizable restructuring and reorganization. The company is also battling an active shareholder in The Stillwell Group who wants to shake up the board by adding members of their choosing.
The analyst said:
Kingsway has clearly been an underperformer but appears to be undertaking the appropriate steps to address the underperformance. However, there remains a confidence gap between investors and management that will only be solved with tangible results and time.
To assess both ING Canada and Northbridge's "hard" book values, the analyst took a look at their current leverage, capital ratios, tangible assets, asset mix and quality, and reserve development.
Both ING Canada and Northbridge have no debt and modest goodwill. The biggest liability of any insurer is the unpaid claims (i.e., reserves) and both companies have a long history of favourable reserve development.
He also added that ING and Northbridge are both well capitalized.
In terms of asset mix and quality, Mr. Reucassel said Northbridge's investment portfolio has performed well in the market downturn, while ING Canada has a healthy bond portfolio. However, ING's preferred share and common share portfolios could act as a drag to earnings in capital over the short to medium term.
The BMO analyst told clients:
We expect the value of preferred shares to deteriorate in Canada over the next couple of years, based on a substantial increase in the supply of preferred shares.
He also noted the dramatic expansion in the amount of preferred shares that banks can now issue to shore up tier 1 capital in the current economic environment.
Mr. Reucassel said investors should also consider the impact that both Northbridge and ING Canada's large parent organizations could have on the future share prices.
Fairfax Financial Holdings Inc. (FFH), who own Northbridge, are firing on all cylinders and might buy back the remaining 40% of shares in Northbridge it doesn't currently own. ING Groep NV, meanwhile, has been hit hard by the credit crisis and should it desperately need to raise capital, could consider selling it's 70% position in ING Canada.