As I start my year-end "keep or cut" list, I'm currently dissecting AXA (OTCQX:AXAHY), the giant Paris-based insurance holding company. I'm trying to determine whether I can reasonably expect to pass this stock along to my children or if I should harvest some very nice gains, pay the taxes, and spread the money across my existing portfolio. My turnover rate is relatively low, fewer than 3 or 4 stocks are swapped out in any given year among my 38 positions. Some years nothing is changed. My goal is to get down to 10-15 core holdings with 5-10 speculative plays around the periphery, so I'm eager to kick out non-performers. I suspect the breadth of my current holdings reflects more a lack of confidence in my due diligence than a reasoned diversification strategy.
I pay much more attention when my own money is on the line so I'll often take a small position in a new entry and then add every time they dip, as long as the original investment thesis holds. Although nerve-racking, this approach allowed me to chase AXA, BAC, C, CIG, OGZPY, LUKOY and others down into the depths of despair. Occasionally they'll pop back into the sunlight leaving me with the happier problem of when to sell and harvest gains. I first bought AXA a little over $18, purchased more just over $10, even more just over $11 and plunked down the final installment on my position a bit over $21. My paper gain is 63% and the dividend at my average price is a smidgen over 6%. For new purchases AXA pays its dividend once a year at a 3.72% rate with a payout ratio of 44%. AXA currently sits above $24 and is very near its high for the past 52 weeks with a 60% rise over the past year. Truthfully I originally bought AXA simply because the price was too good to resist and then the price got even better, but now I need to review the other half of their value equation and determine whether it should stay in the portfolio "forever" or be harvested.
The 6% dividend is obviously somewhat compelling in my case, but doesn't help other investors make a decision. AXA's corporate policy is to pay out 40-50% of adjusted earnings net of undated debt interest charges as dividends, but they have a mixed history on dividends, raising and lowering the dividend over the years as earnings ebbed and flowed.
Given the share price is near my view of fair value I don't expect significant price appreciation near term, but anticipate AXA will continue to chug along with some additional improvement as the Eurozone and the global economy improve. Their strategy makes sense to me and, more importantly, they appear to be hitting the milestones along the path toward their strategic goals. Despite its giant size, AXA in the U.S. ADR trades over-the-counter. The AXA research note from Columbine Capital Services says "sell," the analysis from Ford Equity Research gives AXA their highest rating a "strong buy." So, we have permission from the analyst community to do our own research and decide for ourselves.
My highly derivative view on how to value insurance companies comes down to four simple measures: 1) a long history of honest, conservative financials, 2) a long history of reasonable combined ratios, 3) reasonable responses to troubled times, and 4) a growth strategy predicated on actuarial reality. Insurance companies can't be pushed into growth, they have to be pulled into growth by solid underwriting and competent management building a compelling brand over time. Each of these four valuation metrics can be examined numerically, but is ultimately a subjective judgment call. In my simplistic framework insurance companies are big money pumps. They sell insurance as a loss leader to purchase float, invest the float wisely or not, pay claims rationally and efficiently to build brand loyalty, and then allocate excess capital wisely or dumbly. The wise careful ones grow, the dumb over-eager ones falter. The insurance business is also highly cyclical and these demand cycles typically run over 5-7 years. It is critical to buy insurance companies when the cycle is adverse, earnings are down and losses are high as the prices are much cheaper. This requires looking at insurance companies over a longer period of time so investors don't enter when everything looks great, but only because the cycle is at a high point. My point is, do your research now, pick 1 or 2 companies you really like then wait as long as it takes to buy them cheaply.
We'll run AXA's numbers for the past seven years, review their current strategy, compare AXA to some competitive alternatives and draw a conclusion whether it belongs in or out of our portfolio and whether new investors can expect reasonable returns.
The pricing ratios are the easiest comparisons so we'll look at those first.
AXA P/Cash Flow
AZSEY P/Cash Flow
MET P/Cash Flow
HIG P/Cash Flow
AIG P/Cash Flow
Source: S&P Capital IQ report from Fidelity.com
AXA holds its own across most of these price metrics, but several of these companies might prove interesting investments given the relatively low P/E, P/B, and P/S numbers. Many of these metrics are at roughly half their 2005 levels. However, I wouldn't make a large investment in any of these based on the expectation of multiple expansion. All of these companies are assigned relatively low prices because their growth targets and expectations are low. The entire group is discounted and it seems unlikely all would suddenly be re-priced. AXA's P/E is roughly in line with its strategic growth objectives. The growth CAGR over the past few years is 6% and their target for the next 3 years is 5% to 10%.
At its height in the global bull market of 2007, AXA topped $45 a share then dropped below $10 a share in early 2009 when the bottom fell out. At present AXA is near my fair value calculation based on 2012 earnings, but there appears to be some strong movement in the first half of 2013. I'll update my models at the end of 2013 and determine whether additional investment is prudent. Right now I just need to understand whether this is a solid player where I can enjoy a nice long term relationship and a strong dividend.
In evaluating its strategy AXA's latest investor presentation lays out the basic facts. Earnings are derived from property and casualty insurance 41%, protection and health 25%, asset management 11%, and savings 23%. AXA has 102 million clients worldwide with revenues just over $120B, earnings at $5.74B and 160,000 employees. 12% of its business is in "high growth" developing markets, 24% France, 12% in the U.S., 36% mature Europe, 4% U.K. and Ireland, 11% Japan and 1% other. AXA has roughly $1,206B in assets under management.
AXA's strategy for growth is two-tiered. The first tier named "Ambition AXA" focuses on selectivity, acceleration, and efficiency targets through 2015 for the existing businesses. The goal is to achieve "sustainable growth in earnings and operating free cash flows" in mature markets, for example, Germany, Belgium, Switzerland, Italy, Spain, Portugal, Greece and Luxembourg. Double the company's size in "high growth markets," for example, Morocco, Mexico, Turkey, Gulf region, Hong Kong, Singapore, Malaysia, India, Thailand, Lebanon, Russia, Ukraine and Poland. Efficiency targets and cost reductions of $2.27B overall, especially in the mature markets, are designed to push money into the emerging markets.
AXA's strategic vision is to grow earnings per share in the range of 5% to 10% a year up to 2015. From 1H10 to 1H13 the earnings CAGR was 6%. Adjusted return on equity is targeted for 13% to 15% versus the current range of 12.4% to 16.5% between 1H10 and 1H13. Debt gearing is projected to be reduced from 29% in 1H10 to 25% in 2015. Debt gearing for 1H13 was at 26%.
The second strategic tier called "Preparing for the World of Tomorrow" is about longer term strategies addressing mega trends, accelerating digital investments and leveraging technology around client connectivity. This is obviously not strategic rocket science, but large organizations often require very simple strategies involving extremely complex implementation challenges. AXA's technology may be years ahead in the global insurance field, but could still be decades behind banks, social networking companies and US-based insurance companies like Geico and Progressive. This probably creates opportunities long-term as costs will drop steadily once the enhanced technology is in place. A key part of AXA's strategy is to provide their face-to-face representatives with digital channels to reach a wider range of customers at lower costs.
We can model the impact of Ambition AXA on the company's financials and determine whether hitting the near term targets provides a compelling financial outcome. As we'll see in the Excel chart at the bottom of this article the somewhat modest targets in AXA's strategy result in a very large change over time. There are four areas AXA views as engines of its future growth: commercial lines property and casualty, the direct franchise property and casualty business, SouthEast Asia, and China.
AXA's commercial lines property and casualty business is the 4th largest in the world. This business grew 3.1% in 2012 and they expect to continue or accelerate this growth.
AXA's property and casualty direct franchise business is presented as one of the major catalysts for growth. As noted in AXA's presentation they have a global technology platform available in 9 countries with 5 million policies sold in 2012. 63% of this business was through the Internet. Revenues in FY10 were $2.4B, FY12 $2.94B and projected at $4.27B in FY2015. Earnings were -$69.4 million in FY10, $71.1 million in FY12, and targeted at $200 million in FY15. Combined ratios are expected to improve from 106% in FY10 and 101% in FY12 to <97% in FY15.
AXA's Southeast Asia effort relies on sustaining very robust growth which is already up and running. AXA says it is the #1 P&C in Asia ((excluding Japan)); revenues for this region were up 10%, L&S revenues were up 17% from 1H12 to 1H13.
China is the final growth driver identified by AXA. AXA is expecting to close on 50% of Tian Ping which will provide a distribution footprint throughout most of China. In addition, ICBC, the largest bank in China, and AXA launched a joint venture in July of 2012. AXA is also selling assets in mature markets to free up investments in expanding markets. As noted in the company's August earnings transcript "there are 17 million cars sold in China, only 13 million sold in the U.S." and AXA's stated ambition is to "build the Geico of China."
A reasonable litmus test of their long term strategy is to examine results in the most recent quarter. And, generally, they are tracking ahead of their performance targets. Top line revenue was up 4%, earnings were up 16% with adjusted earnings up 26%, but this includes some one-time gains. ROE was up 16.5%, above the goal of 13-15%, but AXA says there was some seasonality in this number. The combined ratio for P&C was 95.6% with 4% growth rates. Debt gearing was 26%, in line with estimates, and interest coverage improved from 9.3 to 11.6. The original target of $2.0 billion in cost savings was bumped to $2.2 billion by 2015 and AXA believes these numbers are achievable. In mature markets AXA implemented 3-5% price increases and saw continued net revenue growth. They don't have pricing power in all of the company's markets, but are exercising the power responsibly where it does exist.
In one very telling exchange on the earnings call an analyst asked if AXA would release excess reserves. The reserves appeared to be twice the required level or around $12B versus the mandated $5.34B. Mr. Duverne, Deputy CEO, half-jokingly noted they would release the reserves, but it might take 40 years. Compare that to banks which release loss reserves in the same year risk ratios dip.
Is there a clear competitive advantage here or a wide moat creating barriers to competition? Probably not, but AXA appears to be a well-run global insurance conglomerate with no irresistible advantages other than size and conservative intelligence, but also no distressing disadvantages.
Finally, then we'll run the numbers for the next 10 years based on the high and low earning growth estimates of 10% and 5% articulated in AXA's strategy. AXA is clearly, at this point, a dividend stock. No one is going to buy AXA for the growth, although we could all be pleasantly surprised if the company's "Geico-China" model or P&C direct architecture works better than projected. We'll run this analysis at my average dividend rate and at the current payout for a new investor to see if AXA is a missed opportunity or a solid dividend player. Using $2.42 as the 2013 estimated earnings based on AXA s 1H2013 report we'll look at the impact by 2023.
Earnings Multiple Low
Share Price Low
Earnings Multiple High
Share Price High
Low Dividend Yield $15.29
High Dividend Yield $15.29
Low Dividend Yield $24.25
High Dividend Yield $24.25
This analysis starts to explain the real power of "buy and hold." At my average purchase price, assuming AXA achieves the low end of the earnings growth projection, and the dividend is paid at 40% of earnings, then my yield in 2023 would be over 10%. Since my average total yield in the market is likely to be 8-10% this is compelling. In addition to the dividend yield I would get 5% per year in price appreciation if I ever needed to sell. At the high end of the earnings range, and assuming a 50% dividend payout, the yield would be almost 23%. As an average across my other investments, I would be hard pressed to hit this number. Someone else who invests today at the current share price would earn a 6.5% dividend at the end of 2023, assuming the 5% growth rate. If that investor were lucky enough to stay in the game while AXA hit the high end of the growth projections then the dividend yield would be 14%. Even assuming AXA landed somewhere in the middle of these projections it provides a compelling reason to find good, solid, steadily earning companies and buy them when the price is reasonable.
At this point AXA stays on my "keep" list, but it's relatively easy to monitor progress against the published strategy going forward and review this determination each year. We have clearly identified progress milestones and some long-term markers for success. Meanwhile the dividend is a compelling reason to hold pat even though there will be cyclicality, sometimes extreme cyclicality, which induces panic selling or the urge to buy more.
All that being said, I'm going to gift a few shares of AXA to my children for Christmas this year and hope they never have to sell.