In the last ten years the insurance industry has changed dramatically. At the same time as it has been deregulated, the internet has forced it into a new era of price transparency and more competition. Today, canny consumers can save hundreds of pounds at the touch of a button by finding the cheapest cover available on the web.
With lower barriers to entry, new operators such as banks, supermarkets (Tesco, for instance) and online providers (eg, Esure) have flooded into the sector, sending premiums down. Consequently most insurers have survived only by slashing costs, outsourcing non-core activities and differentiating their products by claiming superior customer service.
This is where Innovation, which provides first-rate IT expertise, steps in.
Innovation Group (LSE:TIG), rated a BUY by Altium Securities
The firm has a stable of over 300 insurers as clients, including established operators, such as AIG, Zurich, Aviva and Direct Line, and a few newer players, such as the RAC and Toyota. Innovation Group also operates globally, with divisions across Europe (45% of sales), North America (22%), South Africa (27%) and Asia (6%).
Innovation’s software handles policy and claims management and helps improve efficiency and reduce costs. The firm’s business process outsourcing (BPO) activities also help clients convert prospects into policyholders, together with managing every step of the claims process from quotation to compensation. Together, the BPO and IT maintenance units generate recurring revenues, which represent a whopping 83% of turnover – thus providing investors with solid earnings visibility in an increasingly volatile climate.
So how is the business performing? Not as badly as the share price – down 50% this year – suggests. Instead, Innovation saw record demand in the first half of 2008, winning 25 BPO contracts – and it has just landed another, this time with a specialist British motor insurer worth £5m over three years. The culprit behind the dismal share-price performance has been the business’s cash-burn of £6m in the first half. However, much of this outflow was due to restructuring expenses and the one-off costs from starting new outsourcing deals.
The City is forecasting 2008 sales and underlying earnings per share of £140m and 2.07p respectively, rising to £157m and 2.54p for the year ending September 2009. Thus the shares are trading on forward p/e multiples of only 8.5 and 6.8, which looks far too cheap for such a high-tech outsourcing business with strong prospects. Particularly when Innovation pays a 2% dividend yield and had £5.4m of net funds as at the end of March.
Still, alongside cash management, investors should watch out for adverse foreign exchange fluctuations and problems integrating recent acquisitions. The firm is also still small and hence at risk of being squeezed by bigger rivals. All the same, the sell-off looks way overdone to me. Note that the contract pipeline “has never been stronger” and it could become a takeover target at these depressed levels. The chairman, Geoff Squire seems to agree, as he purchased ten million shares at 21.5p in May. Altium has a 30p target price for the stock. A trading update is expected in the next four weeks.
Recommendation: BUY at 17.5p (market capitalisation £115m)
• Paul Hill also runs a share-tipping service, Precision Guided Investments.