Admiral: Only Way is Up After H1 Results

Company Update (ADM LN) (Buy)

Highlights

• The benefit of price increases is now materializing in the P&L

• U.K. Motor margins rose in H1 and should continue improving

• The cycle is turning and Admiral’s volume should resume growing

• P/E is 20.6x on H1 2023 and 16.1x on 2019; Dividend Yield is 4.3%

• At 2,364p, we see 59% upside (15.8% p.a.) by end of 2026. Buy

Introduction

Admiral Group PLC reported H1 2023 results last Wednesday (August 16). Shares finished the day up 7.2% and rose risen thereafter, ending the week at 16.5% higher than the most recent trough in early July, though still 25% down since the end of 2021 and 36% down from the peak in August 2021:

Admiral Share Price (Last 5 Years)

Source: Google Finance (20-Aug-23).

Admiral’s performance has progressed positively as we expected. In its core U.K. Motor business, prices have been raised decisively in response to inflation, and the benefit is now materializing in its underwriting results; the price increases were ahead of the market and costed 7.4% of its volume, but Admiral looks set to resume growing market share. Reserve releases were again solid. The net result was U.K. Motor Profit Before Tax (“PBT”) rose 2.5% as reported on IFRS17. Most of Admiral’s other businesses showed volume growth and profit improvements. Overall, Group PBT was 4.1% higher under IFRS17, though EPS fell 5.3% due to a higher U.K. tax rate and share-based compensation. We believe group earnings should see good growth in the next few years, driven by improving underwriting margins, volume growth, and continuing substantial reserve releases in U.K. Motor.

At 2,364p, Admiral shares have a 20.6x P/E relative to the cyclically weak H1 2023 EPS, and a 16.1x P/E relative to 2019 EPS (we believe normalized earnings have grown since). the Dividend Yield is 4.3%. Our updated forecasts indicate a total return of 59% (15.8% annualized) by 2026 year-end. Buy.

(For a recap of our Admiral investment case, see our first Substack article on the company in June, as well as our “Top Buys” newsletter last month, when we moved Admiral up to #4 in our “Select 15” model portfolio.)

U.K. Motor Margins Improved as Expected

The most important part of Admiral’s H1 2023 results is that underwriting margins in U.K. Motor have significantly improved, as a result of decisive price increases since 2022 and stabilizing inflation.

Admiral stated it has raised its U.K. Motor prices by 23 ppt in 2023 year-to-date. This followed an increase of 25 ppt between March and December of 2022. (Prior to that, Admiral had raised prices by double-digits for new business but cut them by mid-single-digits for renewals in January 2022, to conform to FCA “price laddering” reforms implemented at the start of the year.)

Admiral U.K. Motor New Business Pricing – Indexed (2021-22)

Source: Admiral results presentation (2022).

Year-to-date, claim cost inflation in U.K. Motor has stayed at about 10% as expected, while claims frequency remains at 10-15% below pre-COVID levels. This means increases in price were ahead of increases in claim costs.

The benefit of the price increases is now materializing in Admiral’s underwriting results, with U.K. Motor recording an initial Booked Loss Ratio of 92% for the Underwriting Year (“UWY”) of H1 2023, improving from an initial Booked Loss Ratio of 104% in UWY 2022, and similar to the figures recorded in the pre-COVID UWY 2018 and UWY 2019:

Admiral U.K. Motor Booked Loss Ratio by Underwriting Year (Since 2018)

NB. Undiscounted and based on IFRS17. Source: Admiral results presentation (H1 2023).

Similarly, U.K. Motor reported a Core Motor Loss Ratio Before Releases of 92.7% in H1 2023, better than the 95.7% figure in full-year 2022 (and much better than the undisclosed H2 2022 figure, given it was only 89.6% in H1 2022.)

U.K. Motor Volume to Resume Growth

Having raised prices ahead of the market, Admiral did lose some volume in U.K. motor, ending H1 2023 with 3.6% fewer vehicles year-to-date and 7.4% fewer year-on-year. However, it should resume growing market share soon.

Its relative competitiveness in U.K. Motor has been improving since last August as competitors started to follow with their price increases; as of July 2023, Admiral’s “Times Top”, the percentage of times its brands appear at the top position on a price comparison website search, was almost back to the level before its March 2022 price increases:

Admiral U.K. Motor “Times Top” (Indexed) (Since 2022)

Source: Admiral results presentation (H1 2023).

Admiral’s U.K. Motor volume has already started to stabilize and should start growing soon, as its Head of U.K. Insurance, Cristina Nestares, explained on the call:

“In the past few weeks, we are seeing our number of customers in Motor stabilizing. So we expect to return to growth in the near future. Now exactly when it's hard to tell.”

Notwithstanding the smaller volume, U.K. Motor grew both its turnover and profits year-on-year in H1 2023.

U.K. Motor Profits Grew in H1

U.K. Motor turnover grew 19.6% year-on-year in H1 2023, with price increases more than offset a 7.4% lower volume:

Admiral U.K. Motor No. of Vehicles, Turnover & PBT (Half-Yearly)

Source: Admiral company filings.

Admiral implemented IFRS17 accounting standards at the start of 2023 and, based on IFRS17 figures, U.K. Motor PBT was 2.5% higher year-on-year. H1 2022 U.K. Motor PBT restated under IFRS17 is 8.3% lower than the original figure under IFRS4, and much of the difference is a one-off transition impact, but at worst U.K. Motor has achieved a similar PBT year-on-year – a strong achievement given elevated claim cost inflation in H2 2022 and H1 2023 still being burdened by some policies priced before the March 2022 price increases.

The stronger H1 2023 U.K. Motor PBT was the result of a slightly weaker Core Loss Ratio Before Releases being more than offset by higher investment income and higher reserve releases:

Admiral U.K. Motor Profits (H1 2023 vs. Prior Year)

NB. U.K. Motor PBT was £251.7m in H1 2019 under IFRS4. Source: Admiral results release (H1 2023).

U.K. Motor contributed substantially all of Admiral’s PBT in H1 2023, just as it did in prior periods. However, most of Admiral’s other businesses also showed volume growth and profit improvements.

Solid Performance Outside U.K. Motor

All of Admiral’s other segments showed year-on-year improvements in their PBT under IFRS17, with European Motor turning profitable again, U.S. Motor making a smaller loss, and U.K. Household doubling its PBT from £4.3m to £8.7m (albeit helped by a one-off commutation; the reported Loss Ratio worsened year-on-year):

Admiral PBT Outside U.K. Motor (H1 2023 vs. Prior Years)

NB. Excludes “Other Group Items”. Source: Admiral company filings.

Volume grew in U.K. Household, in U.K. Travel & Pet, in each market in European Motor and in Admiral Money. The only business that reported a volume decline was U.S. Motor, where the number of vehicles shrunk from 0.24m to 0.22m as management focused on protecting margin and capital. (The U.S. business continues to be under strategic review, and is no longer shown as part of Admiral’s strategic business model; we believe it may be sold or liquidated.)

We are not concerned by the weaker underwriting performance in U.K. Household, given it is a relatively small business, Admiral has gained 14% in volume year-on-year while also raising prices significantly, and there are signs that sector prices have started to increase materially after a weak decade.

In general, businesses outside U.K. Motor are not a material part of our investment case, but have some natural synergies with U.K. Motor (in the case of U.K. Household), represent potential upside (especially in the case of Europe Motor) though can also mean a negative tail risk (in the case of the U.S. business and Admiral Money).

Admiral H1 Group P&L

Overall, Group PBT was 4.1% higher year-on-year in H1 2023, though EPS fell 5.4% due to a higher U.K. tax rate and higher dilution from share-based compensation:

Admiral Group P&L (H1 2023 vs. Prior Years)

NB. H1 2019 figures are based on continuing operations figures in H1 2022 results release, plus our own estimates. H1 2019 included £33.3m headwind in U.K. Motor from Ogden rate change. Source: Admiral company filings.

We have included a comparison with the original H1 2019 figures under IFRS4. IFRS17 and IFRS4 earnings should not be significantly different under “reasonably normal trading conditions”, according to management. While H1 2023 PBT is shown as 11.1% (£23.4m) higher than in H1 2019, the latter had a negative impact of £33.3m from an Ogden rate change that year. On a like-for-like basis, we believe H1 2023 PBT was still about 4% lower than in H1 2019, and Net Income was about 11% lower due to the U.K. Corporation Tax rate increase (from 19% to 25%) in April 2023.

More importantly, we believe group earnings should see good growth in the next few years.

Solid Earnings Growth Ahead

Admiral should see solid earnings growth in the next few years, driven by a number of trends in U.K. Motor.

Improving underwriting margins will be a key trend, and should come naturally over time. With U.K. motor insurance policies mostly on annual terms, the time lag between price increases being decided and the entire customer base being repriced has been a drag on profitability. As shown in the “Admiral U.K. Motor New Business Pricing” chart above, most of Admiral’s price increase last year took place between March and June of 2022, after inflation spiked up follow the Russian invasion of Ukraine in February, meaning some policies written in the early part of H1 2022 were not priced high enough. H1 2023 is the last period when any of these policies were in force, so underwriting margins should naturally improve thereafter. CFO Geraint Jones said so explicitly on the call:

“I think the 92% (initial Booked Loss Ratio for H1 2023) will improve. We … expect to continue to increase prices in the second half, subject to what we see on claims inflation, but that's definitely our expectation.”

Volume growth will be another trend. The number of U.K. vehicles insured by Admiral has fallen 7.4% in the twelve months to June 2023 month-end, the first period since 2013 when Admiral did not grow. This was due to Admiral raising prices ahead of the market, and has started to reverse as competitors also found it necessary to raise their prices. Management expects U.K. Motor volume growth to resume eventually and we agree.

Reserve releases should continue to be substantial. Reserves releases from UWY 2021 and UWY 2022 will be weaker, because inflation jumped ahead of the expectations after March 2022. However, as we explained in our June article, reserve releases from each underwriting year tend to be spread fairly evenly over time, and conversely each reporting period’s reserve releases tend to be broad-based across different underwriting years. So the effects of the 2021 and 2022 underwriting years may linger for some years but will likely be moderate in each annual P&L.

Reserve releases were actually higher year-on-year in H1 2023, and Jones has stated that he was “confident in strong reserve releases moving forward”, given the built-in prudence in Admiral’s historic reserving policy. In addition, reserve releases may also be helped by the company moving its U.K. Motor reserve position from the 94^th percentile to the 90^th percentile (now that uncertainties from the pandemic years are dissipating) and the Ogden discount rate potentially being revised upwards at the next review in late 2024 or early 2025 (following higher interest rates).

Admiral Stock Valuation

At 2,364p, Admiral shares have a 20.6x P/E relative to the cyclically weak H1 2023 EPS:

Admiral Earnings & Valuation (H1 2023 vs. Prior Periods)

NB. 2019 Net Profit excludes negative impact of Ogden rate revision (£33m before tax). 2022 dividend figures exclude Price Comparison Website disposal proceeds (45p). Source: Admiral company filings.

Relative to original 2022 earnings reported under IFRS4, the P/E is 19.3x. Restated 2022 earnings under IFRS17 is 23% lower, largely due to a one-off transition impact, and is not representative in our view.

In addition, we believe both 2022 and H1 2023 earnings both understate Admiral’s normalized earnings power, given elevated claim cost inflation in 2022, the time lag before price increases flow through the entire customer base, and severe U.K. weather in 2022 (costing £31.6m in PBT).

Relative to 2019 earnings reported under IFRS4, adjusted to a continuing operations basis and to exclude the impact of the Odgen rate revision that year, the P/E is 16.1x. This is likely a more meaningful valuation metric, as underwriting margins were reasonably normal that year, and IFRS17 earnings should be close to IFRS4 earnings under normal conditions. Subsequent developments means that normalized earnings have likely grown moderately since 2019, given Admiral finished H1 2023 with 9% more U.K. vehicles than in 2019, businesses outside U.K. Motor have become more profitable, and investment income has increased with higher rates; these should more than offset the higher U.K. Corporation Tax rate (which represents a 7.4% headwind to Net Income).

The interim dividend for H1 2023 was 51.0p, implying a Dividend Yield of 4.3% (annualized). The interim dividend was equivalent to 89% of H1 EPS, in line with Admiral’s historic policy of targeting a Payout Ratio of “around 90%”, which was reaffirmed as part of H1 results.

Admiral Return Forecasts

We keep the assumptions in our Admiral forecasts substantially unchanged, and extend them by a year to 2026:

• 2023 Net Income to be £414m, 7% lower than in 2019

• From 2024, Net Profit to grow at 8% annually

• Share count to grow at 1% annually

• Dividends to generally be 90% of EPS

• 2026 P/E of 20.0x, implying a 4.5% Dividend Yield

Our new 2025 EPS forecast is unchanged at 155.4p; our 2026 EPS forecast is 166.2p:

Illustrative Admiral Return Forecasts

Source: Librarian Capital estimates.

With shares at 2,364p, we expect an exit price of 3,724p and a total return of 59% (15.8% annualised) by 2026 year-end, driven by a continuing earnings recovery, dividends and an upward re-rating.

We reiterate our Buy rating on Admiral.

Ends

Stocks mentioned: ADM LN. We are long Admiral.

Disclaimer: This article consists of personal opinions, based on information believed to be correct at the time of writing, but not guaranteed. We undertake no responsibility in updating content in this article. Nothing published here should be taken as financial advice.