It’s been an amazing seven days. There seemed a faint chink of light at the end of the sub-prime tunnel when Standard & Poor’s (S&P), the US debt rating agency, suggested that the final bill for sub-prime would be contained to around $285bn. But just 24 hours later, hopes were dashed when the Federal Reserve was forced to bale out Bear Stearns, Wall Street’s fifth-largest investment bank. Stockmarkets were duly hammered. Yet we could be entering the final throes of the bear market. Spectacular bankruptcies inevitably trigger a crescendo of panic-selling and can force concerted central bank intervention. If we can start to draw a line under all this, there may be better prospects ahead. Adopting a more sanguine outlook, thick-skinned investors may wish to dip their toes into the beaten-up non-life insurance sector. Take this stock, for example…
Brit Insurance (BRE), tipped as a BUY by ABN Amro
Brit Insurance underwrites a broad range of risks, such as for natural disasters, director and professional indemnity, and marine, aerospace and motor cover.
On 10 March, Brit reported a solid set of results, with 2007 earnings per share up 4.6% to 43.2p, driven by 6.7% like-for-like growth in premiums and bumper investment returns. This was a creditable performance; the group was hit by one-off claims relating to the summer floods (£14.2m) and £62.5m of sub-prime provisions, leading to a rise in the combined (cost/income) ratio to 92.7% from 86.9% in 2006. The solid return from investments – mainly quality fixed-interest bonds – came despite “unusually difficult conditions”.
Even after such testing times, Brit showed its mettle and posted a 12.4% gain in net tangible assets to 248p per share, and proposed a 15p dividend on top of a one-off payout of 7p a share. While the Board is aiming for a 5% rise in premiums this year, the sector is becoming more competitive, especially for catastrophe cover after two fairly benign hurricane seasons. As such profit margins will be squeezed and the City expects lower 2008 and 2009 earnings per share of 35.5p and 31.1p respectively, but with the dividend rising by 6% a year. Brit trades on an attractive 2008 p/e of 6.4 and pays over 7% as dividend yield – which looks far too cheap.
So why is the stock rated so poorly? Well, while not exposed to material sub-prime assets in its investment funds, it does sell insurance policies that could lead to claims against potentially negligent directors or advisers of banks. The impact of this exposure on the entire insurance industry is thought to be around $6bn. To date Brit has received notifications from 25 parties which may lead to claims. Of those that have specified amounts, the net cost to Brit would be £12.7m – or 21% of its provision.
Although fears of sub-prime losses grab the headlines, it is worth putting this into perspective. Brit wrote gross premiums of £163m in 2007 for these types of risk, yet still delivered a profit even after exceptional charges. It is impossible to say whether the £62.5m reserve is sufficient, but chief executive Dane Douetil said that “we think it is very prudent… Brit Insurance is built to weather storms and is positioned for outperformance.”
Other industry risks to consider include exposure to natural disasters, foreign-exchange fluctuations, downgrades to its credit-rating and poor performance from its investment activities. But Brit’s capital position remains strong and the board is “confident of continued success” despite the downturn in the economic outlook.
Recommendation: speculative BUY at 227.5p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments