My personal approach to stock picking revolves primarily around book value based metrics: price-to-book (P/B), book value growth, return-on-equity (the key determinant of book value growth), retention ratio (the opposite of Payout ratio), intangibles ratio, etc. In today's market, it's hard to find equities that have a low P/B ratio but at the same time sport a high RoE. Munich Re (OTCPK: MURGY) is one that caught my eye recently; here is a snapshot of Munich Re's key metrics:
Payout Ratio: 38.9% (Yield: 4.39%)
Book value per share* (€)
Return on Equity (%)
(Source: Munich Re Annual Report 2012)
*Munich Re is listed in US as an ADR (10:1), book values are per original share in Germany.
As can be seen, during the past 5 years, Munich Re has grown its book value at a CAGR of 9+%. During this same period, it has also been paying an attractive dividend and aggressively buying back its shares:
Dividends Paid (€m)
(Source: Investor Relations MunichRe.com)
Since 2006 Munich Re has cumulatively repurchased over 52 million shares, reducing its float by more than 20%. In addition, Munich Re has excellent credit ratings -- its most recent debt issuance (Subordinate bond 6.25, due 2042) was rated A+ by A.M. Best, and A by both Fitch and S&P respectively (I pay close attention to credit ratings, because in my view the rating agencies have access to substantially more information when making determination about a company's long and short-term financial health, than I could ever using information available from the public domain).
The biggest vote of confidence in the company's strength comes from none other than the venerable guru of value investing: Mr. Warren Buffett - Mr. Buffett is the single largest shareholder in Munich Re, owning 11.2% of all shares outstanding (as of Nov/20/2013).
Munich Re (Münchener Rückversicherungs-Gesellschaft) is the world's largest reinsurance company with €258 billion in assets, annual revenues of €52 billion (2012) and 45,000 employees on its payroll. The company is headquartered in Munich, Germany and is listed on the Frankfurt exchange (MUV2:GR).
Despite North America contributing approximately 32% of company's revenues, and being home to 38% of its shareholders and 14% of its employees -- Munich Re does not sponsor an ADR in the US. However, American investors can purchase Munich Re via an unsponsored ADR established by BNY Mellon (ratio of the ADR to underlying stock is at 10:1).
Munich Re engages four lines of business - Reinsurance (property-casualty and life), Primary Insurance (life, health and property-casualty), Asset Management and Munich Health. Reinsurance accounts for majority of company's revenues, although the other three divisions have significant and wide-reaching global operations - with partially or fully-owned subsidiary companies in most countries, including at locations as varied as Abu Dhabi, Cape Town and Istanbul.
Despite the breadth of reach of its primary insurance operations, the profitability seems to be concentrated in the Reinsurance line of business -- the table below shows YTD (Q1-3) net income (€ m) segmented by lines of business:
(Source: Munich Re Quarterly Report Q3 2013)
As can be inferred, during this period nearly 80% of the company's income was generated by the reinsurance business.
Reinsurance Industry: Is a Kodak Moment Looming?
One of the consistent patterns in the world of business is that of disruptive innovations which sweep through an industry and gravely wound titans, who at one time seemed untouchable. Just as digital photography drove a stake through the heart of Kodak's film business, so is a relatively new type of alternative security -- catastrophe bonds (usually called "cat bonds") -- threatening the traditional reinsurance business.
Here are some quotes from a recent Reuters article on cat bonds' impact on the reinsurance industry:
"While a continued inflow of alternative capital has the potential to alter the core business model of reinsurers, many firms in the sector have been preparing for this eventuality for years," said James Eck, a senior credit officer at Moody's"
"Reinsurers who aren't willing to adapt or try and stay ahead of the curve are going to be pushed to the sidelines or pushed out," said Dennis Sugrue, a reinsurance specialist at S&P."
Reinsurance is essentially the transference of excess risk from one insurer to another - for example, a life insurance company may write you a policy basing the probability of your untimely demise on actuarial data. However, there exists a tiny probability that a major pandemic outbreak (or a natural disaster in your densely populated city) will kill you and most of your city's residents unexpectedly. Insurance companies protect against these types of high-impact catastrophe events by purchasing reinsurance from the likes of Munich Re (other major players in the industry include Swiss Re and General Re).
Within the reinsurance industry, the larger market segment is not life insurance; rather it is the property & casualty insurance. Property & casualty reinsurers provide excess insurance against events such as say -- a hurricane that decimates broad swaths of expensive beachside properties, or an earthquake that rips apart a major city - events that could bankrupt insurance companies if reinsurance were not available.
Enter cat bonds - which essentially are the securitization of the "catastrophe risk" and transference of this the risk onto the financial markets. Cat bonds pay an interest to the holder as long as the event insured against does not occur. And if the 100-year flood does occur, the bond gets wiped out. Insurers are increasingly turning to cat bonds instead of going to reinsurers - the cat bond market has been experiencing record issuances year-after-year, with another record-setting $7.2 billion in new issuances in 2013. According to Fitch, the outstanding market for cat bonds now stands at $20 billion.
So how is Munich Re holding up against this threat? It's hard to tell. YTD comparisons between 2012 and 2013 show that reinsurance derived net income is down at Munich Re - for both property-casualty and life. But of course, this is too short a period to either be an effective comparison or to extrapolate into any type of trend or conclusion. And although issuance of cat bonds has been accelerating rapidly in recent years, the financial instrument itself has been in existence of more than a decade now. For some years now, Munich Re too has gotten into the game of issuing cat bonds -- although it's hard to see the cat bonds business as being even close to as lucrative as the reinsurance business.
Despite the long-term uncertainties arising from the cat bonds, Munich Re remains a solid cash flow generating machine - the management scores very highly on shareholder value creation and astute stewardship of the company. Partaking in the unassailable wisdom of Mr. Warren Buffett, I plan on purchasing a fraction of this company soon (albeit, the exceedingly miniscule fraction that I can afford).