Australia | Jul 31 2014
-Will the strong H1 repeat in H2?
-Potential for earnings upgrades, returns
-Underpinned by pay-out ratio, div yield
By Eva Brocklehurst
Genworth Mortgage Insurance Australia ((GMA)) beat expectations with its maiden first half profit as a listed entity. A better claims experience has led management to upgrade FY14 guidance by around 8% relative to the prospectus. Lower claims and improved pricing had a positive impact on profitability with a commensurate reduction in the claims, or loss, ratio outlook versus the prospectus.
Macquarie is impressed with the lower average pay-out on claims. The company continues to benefit from the current environment of low interest rates and house price appreciation. A higher proportion of claims were paid in respect of the 20% quota share reinsurance. As Genworth's direct book pay-out falls so does the average paid claim. One of the negative aspects of the first half for Macquarie was a deterioration in the primary delinquency rate, to 36 basis points in the second quarter from 34 basis points in the first quarter. The broker acknowledges there is some seasonality involved, as the first half typically reveals higher net new delinquencies after Christmas and the summer holidays. Another aspect that Macquarie found fault with was that net new delinquencies increased 5.3% over the prior year's comparison.
In Macquarie's opinion the company is well placed to deliver earnings upgrades and announce a capital return in the future. This could be enhanced through changes to the conservative capital structure. Management has flagged opportunities to move lower down the credit curve and potentially reinvest cash to lengthen debt duration. Current forecasts do not factor in any capital returns but Macquarie remains confident the company can improve capital efficiency in the next two years. June 2016 is the first call date on existing debt.
CIMB upgrades FY14 and FY15 profit forecasts by 5.8% and 3.3% respectively. Having done that, the broker suspects the strong outcome in the first half is unlikely to be repeated, and the company will struggle to boost its return on equity to much above its cost of capital. To address this, the company is expected to review options regarding investments, gearing and reinsurance. The broker suspects the trough in losses for this cycle was reached in the first half, and rising delinquencies and slower house price momentum could weigh going forward. Still, Genworth's capital position is healthy and the flexibility from reinsurance and gearing should allow future increases in the pay-out ratio. CIMB maintains a Hold rating.
The first half dividend was also ahead of Goldman Sachs' expectations, at 2.8c versus 2.1c. The capital position remains strong and the broker raises forecasts for FY14 by 6%. Goldman continues to believe Genworth will benefit from an improving returns trajectory, as previously implemented price increases flow through and lower returning cohorts roll off. The stock remains attractive and the broker reiterates a Buy rating.
The better claims experience drove a ratio of 19.6% in the first half. This was much better than brokers expected. Management has pulled back the expected FY14 claims ratio to 25-30%, from the prospectus forecast of 30.2%, but Goldman believes the company is erring on the conservative side. Even at the bottom end of guidance the second half claims ratio would be 30%.
Moreover, the reasons management provided as to why the claims ratio may move higher in the second half also imply a degree of conservatism. The unemployment rate has ticked higher but Goldman believes the main thrust of this uptick is a rise in the workforce participation rate and this should have no implications for delinquency rates. House price increases are slowing, and the broker concedes they are unlikely to grow to the extent of the first half, but house prices remain supportive. Goldman forecasts the claims ratio to be more like 25% for FY14, noting that every 1% shift in this ratio alters underlying profit by nearly 1.5%.
UBS remains concerned about an external macro shock and how the company will respond in a rising interest rate environment. As long as earnings revisions are underpinned by positive claims trends Genworth could trade through book value. The broker observes softer premium growth could be an issue, although the company appears confident that major client activities will underpin growth and a skew back to higher loan-to-valuation ratio lending. Head room on the pay-out ratio, at 60% versus the 50-70% target, and a strong dividend yield underpin a positive outlook and UBS remains content with a Buy rating.
On FNArena's database there are two Buy ratings and one Hold. The consensus target is $3.65, suggesting 2.7% upside to the last share price. The dividend yield on FY14 and FY15 is 5.1% and 7.2% respectively.
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