StoreBrand: Conservative Scenario Gives Up To 20% Upside Potential

| About: StoreBrand ASA (SREDY)

Summary

StoreBrand is a Norwegian insurance company focused on the life insurance and pension markets.

The company has undergone significant business restructuring over the past few years to adapt itself to the current low interest rates environment and the introduction of Solvency II.

Its current capitalization is acceptable and has enabled StoreBrand to resume dividend payments after years of omission.

StoreBrand is clearly undervalued, and this seems to reflect mainly its past woes, the market not giving much merit to its dividend growth prospects.

As income investors start to consider StoreBrand as a dividend play again, a re-rating should occur given its deep valuation discount to peers.

(Editor's note: There is much greater liquidity for StoreBrand on the Oslo exchange under the ticker STB.)

StoreBrand (OTCPK:SREDY) is a leading insurance company in the Nordic market which has been under a restructuring program over the past few years. It has taken decisive measures to lower balance sheet risk and reduce its dependence on guaranteed products. This has improved the company's business profile and capitalization, enabling it to resume dividend payments recently. However, its valuation is still at a deep discount to that of its closest peers, and a re-rating seems warranted, giving StoreBrand plenty of upside potential.

Company Overview

The StoreBrand Group is a leading insurance company in the Nordic market, especially concerning long-term savings and insurance. It is based in Oslo, Norway, and was founded in 1767. The company has about 1700 employees and a total of 1.9 million customers in its domestic market and Sweden. It has a market capitalization of about $3 billion and trades in the U.S. on the over-the-counter market. Its competitors are other Nordic insurance companies, such as Sampo (OTCPK:SAXPY), Topdanmark (OTCPK:TPDKY), Gjensidige (OTCPK:GJNSY) and Tryg (OTC:TGVSY).

StoreBrand's main businesses are the guaranteed pensions and life insurance segments, but the company also has operations in savings, property & casualty (P&C), asset management and banking. Its distribution model is mainly based on agreements with third-parties, with a small number of own sales offices. The insurance markets in Norway and Sweden are characterized by high concentration and good profitability levels, which bodes well for StoreBrand's business profile.

Even though the majority of its earnings comes from the insurance segment, StoreBrand targets growth mainly from other areas, like asset management. In the past few years, its assets under management (AUM) have increased steadily to more than $67 billion in 2016, leading to higher results from asset management and increasing the business weight within the group.

Additionally, ageing populations in the Nordic countries should be a supportive factor for savings and pensions products in the long term, leading to good growth prospects in this area for StoreBrand.

Business Restructuring

StoreBrand is a leading player in the Norwegian pension market, given that its market share of defined contribution plans is about 34%. However, the market has undergone significant change over the past few years due to changing regulatory conditions and low interest rates. In the past, most pension products offered guaranteed interest rates, which aren't much profitable for pension managers under the new operating environment.

Therefore, as a leading company in this market, StoreBrand has heavily impacted by this changing environment within the pensions market, and for the past five years, has been under a significant restructuring program.

The company's goal was to better adapt its business model to the current environment of low interest rates and the introduction of the new insurance regulatory regime in Europe in 2016, called Solvency II. StoreBrand's business had too much reliance on capital-intensive guaranteed products, which were heavily penalized under Solvency II regarding capital requirements.

Taking this new reality into account, StoreBrand started a shift away from its traditional pension plans with guaranteed annual interest rates (the "back book") to products without guarantees (the "front book").

The company is now more focused on sales of unit-linked products, which don't have guaranteed interest rates, and contribution-defined pension schemes. The unit-linked pension market has experienced good growth in the last few years in StoreBrand's markets, supporting its switch to capital-light products. The company expects to grow unit-linked assets at about 15% annually in the next two years.

Reflecting its push for capital-light products, more than half of its assets under management are now non-guaranteed, and the weight of these products on StoreBrand's profits is about 70%. The weight of guaranteed products should continue to decline naturally in the next few years, as new inflows are practically closed. StoreBrand expects that back book peak capital consumption should occur in 2018 and should start to decay after that.

Financial Overview

Regarding its financial performance, the company has delivered mixed results over the past few years. While revenues have been relatively stable despite the low interest rate environment, its profits were negatively impacted by increasing reserve provisions for longevity risk.

Like its peers, StoreBrand was impacted by the Norwegian regulator's decision to introduce a new mortality base in 2014 for pension funds and life insurance companies. This led to increased premiums, but more importantly, higher insurance technical reserves to cover future liabilities.

This change in the mortality base resulted in higher longevity risk and the need to increase provisions to take into account for higher technical reserves. Indeed, in 2015 StoreBrand reported more than $200 million in one-off provisions related to longevity risk in its pension fund business, impacting its group profits negatively.

More recently, StoreBrand's 2016 results were quite good, as the company reported improved results and profitability, showing the benefit of the business restructuring performed in the past few years.

Its overall insurance premiums remained relatively stable in the past year at about $600 million, with about 62% of premiums coming from corporate clients, while the rest is from the retail market. In unit-linked products sales increased by 16%, reflecting the company's push for this type of product. This was supportive for StoreBrand's operating income as well its good cost control. In 2016, its expense base declined 4% from the previous year, and further cost reductions should come mainly through automation and outsourcing.

Supported by the company's relatively good operating environment, StoreBrand's group profits amounted to about $250 million. This was an increase of 55% from the previous year, explained by the one-off provisions booked in the previous year, but also by higher financial results in 2016.

Its return on equity (ROE) was 9.6%, very close to its target of an ROE higher than 10%. StoreBrand's ROE has been quite good, with an average of about 9% over the past five years despite the business restructuring performed during this period. Therefore, the company should be able to achieve its ROE target in the coming years.

Capital & Dividends

Regarding its capitalization, StoreBrand was able to enter into to the new Solvency II regime without performing a capital increase - something that the market was quite worried about a few quarters ago, because StoreBrand had a relatively weak solvency ratio. However, the company was able to avoid a capital increase and further improved its capitalization in the past two years.

StoreBrand reported a Solvency II ratio of 157% at the end of 2016, which is an acceptable level, even though it is not among the best-capitalized insurance companies in Europe. This solvency ratio is within the company's comfort zone, as it considers itself properly capitalized in a range of 150-180%, allowing it to distribute dividends in the current operating environment.

StoreBrand expects capital generation of between 5-10% per year in the next few years, mainly from earnings and the run-off of guaranteed liabilities. If the company achieves a solvency ratio above 180%, it may consider performing share buybacks and increasing its dividend payout, but this should take some time to achieve given its current solvency ratio of 157%.

Nevertheless, StoreBrand's normalized capital situation has enabled the company to resume dividend payments after several years of not distributing any dividend to its shareholders. This marks a clear shift in the company's strategy, from improving its business profile and capitalization to cash distribution. Its dividend policy is to pay at least 35% of annual profits if its solvency ratio remains above 150%.

The company will pay an annual dividend related to 2016 earnings for the first time since 2011, which was set at NOK 1.55 ($0.18) per share. At its current share price, StoreBrand offers a dividend yield of 2.7%. Its dividend payout ratio was set at 35% - a level that is at the bottom of its target and below the European insurance sector average.

Therefore, StoreBrand has good dividend growth prospects given its earnings growth potential, capital generation and below-average dividend payout. Indeed, according to analysts' estimates, it should deliver a growing dividend in the next few years to about NOK 3.60 ($0.42) by 2019 and become a high-dividend yield stock during this period.

Conclusion

StoreBrand has undergone a significant business overhaul over the past few years and seems now to be in a much stronger position, due to its increasing focus on capital-light products and relatively good growth prospects in areas like savings and asset management.

Its recent announcement of a dividend payment clearly reflects a strategy shift away from balance sheet improvement to cash distribution. StoreBrand has achieved a stable capital position that should continue to improve over the next few years due to its organic capital generation, which should also support higher dividends.

The Nordic insurance companies are known for their high ROEs and high dividend yields, justifying a large premium valuation compared to their European peers. However, StoreBrand is currently trading at 0.92x book value and 12x its forward earnings, while its closest Nordic peers trade on average at about 3x book value and more than 15x earnings. The European insurance sector is trading at about 1.7x book value, showing how undervalued StoreBrand is right now.

StoreBrand's valuation is currently quite undemanding, reflecting its past profile of a company with a high capital intensity and lack of dividend payments. One of the main attractive factors of the European insurance sector has been its historically high dividend yield - something that StoreBrand lacked for years and was clearly punished by its low valuation. However, the company's discounted valuation does not seem to reflect its good dividend prospects, making the current risk/reward profile quite attractive for investors.

Even though StoreBrand's share price has reached recently a 52-week high, it still has good upside potential given its discounted valuation. A re-rating seems to be clearly justified, and the payment of its first dividend in several years (expected on 21st April) may be an important catalyst. Additionally, the company's discounted valuation does not seem to reflect its good dividend prospects, making its current risk/reward profile quite attractive for investors.

The European insurance sector is driven to a large extent by yield considerations, and StoreBrand should be sought after by income investors again, after years of being neglected by these type of investors due to its lack of yield. StoreBrand has a good capitalization and high ROE, justifying a valuation of between 1.2x and 1.3x book value considering a cost of equity of about 8%. At this valuation, the stock easily offers an upside potential of between 10-20% and would still trade at a significant discount to its peers.

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Disclosure: I am/we are long SREDY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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Tagged: , , , Property & Casualty Insurance, Dividend Increase, , Foreign Stock, Lagging Market Sentiment, Multiple Expansion, New Market Opportunity, Norway, Pro Contest, Relative Valuation, Restructuring, PRO, Underfollowed, Value
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