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Contest: Warren Buffett’s Munich Re (MURGY) – 50% Upside to Fair Value

December 01, 2011 | About:
Introduction: Munich Re (MUV2.DE)(MURGY.US), headquartered in Munich, Germany, is the world’s largest reinsurer in terms of both revenue and equity. Its shares were first admitted to trading on the stock exchange in Munich on 21 March, 1888, and there are more than 47,000 employees with over 13,000 in reinsurance, 33,000 in primary insurance and 800 in asset management.

Reinsurance companies basically insure insurance companies as well as their competitors (known as retrocession). Insurance companies cede risk to reinsurance companies in a variety of ways however these are beyond the scope of this article. Reinsurance economics basically mirrors insurance economics. Those companies that underwrite using incorrect policies will make an underwriting loss. Munich Re prides itself on writing solid policies on prices that make sense. If prices don’t make sense they walk.

Property-casualty insurance, and reinsurance as well as health reinsurance consist of short-term lines whereas life primary insurance and the bulk of health primary insurance offer longer-term tails.

A five-year key figure summary is shown in the following table:



2010


2009


2008


2007


2006


Gross Premiums Written € billion


45.5


41.4


37.8


37.3


37.4


Operating Result €m


3,978


4,721


3,884


5,573


5,877


Consolidated Result €m


2,430


2,564


1,579


3,923


3,519


Investments € billion


193.1


182.2


174.9


176.2


176.9


Return on Equity %


10.4


11.8


7.0


15.3


14.1


Equity € billion


23.0


22.3


21.1


25.3


26.3


Net Technical Provisions € billion


171.1


163.9


157.1


152.4


153.9




Group activities encompass life reinsurance (19% of premiums), property casualty reinsurance (33 %), life primary insurance (12%), health primary insurance (12%), property casualty primary insurance (12%), Munich health — basically primary health outside of Germany (12%) — and asset management. The group’s worldwide assets which amount to just under €200 billion are managed by MEAG.

At the end of 2010 fixed-interest securities were worth €112.35 billion and non-fixed-interest securities came to €9.77 billion. Carrying amounts were as follows:



Fixed-interest Securities


€ billion


Government Bonds


Germany


7.59


Rest EU


26.6


USA


11.19


Other


9.23


Corporate Debt Securities


47.14 (over half are pfandbriefs)


Other


10.58


Non-Fixed-Interest Securities


Shares


6.03


Investment Funds


Equity Funds


0.5


Bond Funds


1.96


Real Estate Funds


.54


Other


.73




As at the third quarter 2011, €1 billion was written down on Greek bonds, and Italian bond exposure was reduced by €1.4 billion. German Insurance company Allianz (AZ) has left their Italian bond exposure untouched suggesting that the Euro crisis is blown out of proportion. Either way Munich Re’s move shows their cautious operating approach. By my estimation MUV2 still has around €3 billion Italian bond exposure though I wouldn’t be surprised if more bonds have been unloaded recently. Strong gains were made on German and U.S. bonds during the third quarter.

Three percent of total government bonds are from Portuguese, Irish and Greek issuers. Again, I would not be surprised if these positions were wound down further.

Almost all of Munich Re’s primary insurance premiums are derived in Europe (99.3%) with nearly all of the reinsurance premiums coming from North America (+- 43%) and Europe (38%). Further exposure comes from Asia, Australasia, Latin America and Africa, as well as the Near and Far East. Munich Re is looking to extend its activities in India, South Korea and China.

The flagship business is the reinsurance property and casualty (P&C) business providing about 60% of gross written premiums. Sales channels consist primarily of the group’s strong sales organizations, broker relationships, extensive marketing cooperations and collaboration with the Unicredit group.

A five-year history of segment combined ratios follows:

Reinsurance (Property Casualty)



Year


2010


2009


2008


2007


2006


%


100.5


95.3


99.4


96.4


92.6




Primary Insurance (Property Casualty)



Year


2010


2009


2008


2007


2006


%


96.8


93.2


90.9


93.4


90.8




Munich Health



Year


2010


2009


%


99.7


99.4




Munich Re reports under IFRS except for underwriting which is reported under US GAAP.

With 177,588,750 shares in issue the market capitalization of MUV2 at €83.50 equals €14.82 billion. There were 140,000 shareholders on the share register at the end of December 2010. The share register is broken down per location as follows:



Country


%


North America


29.9


Rest of Europe


28.6


Germany


27.3


UK


13.6%


Other Countries


0.6




On a personal note I am currently residing in the Republic of Ireland and have no problem investing in strong German companies. Several friends who reside in the U.S. have expressed their desire to spread their investment risk from the US dollar to the euro and other denominations. Germany is the strongest industrial sovereign in Europe which continues today as shown by Merkel’s stance when dealing with other euro leaders in order to solve the euro debt crisis.

Management

Nikolaus von Bomhard is Munich Re's CEO. Von Bomhard joined Munich Re in 1985, after earning a doctorate in law, and was appointed CEO in 2000. He is 55 years old.

Munich Re has eight other board members, including Jorg Schneider (finance director) and Torsten Jeworrek (chairman of the reinsurance committee), each with considerable experience in the industry. All members except for two have at least five years experience in their current role.

Management is strong and conservative.

There are 20 members of the supervisory board. More information on management can be found here:

http://www.munichre.com/en/group/management/board_of_management/default.aspx

Competitors

Major European reinsurance competitors include Hannover Re (HNR1.DE), Swiss Re (RUKN.VX), General Re (part of Berkshire Hathaway (BRK.A)(BRK.B) and SCOR (SCR.PA). However, Munich Re is easily the largest company compared on both a net asset and written premium basis. Furthermore Munich Re sets itself apart from its competitors by utilizing an insurance/reinsurance model which, in 2009, was split approximately 50/50. Economies of scale also factor as an advantage for Munich Re, as smaller businesses may not get access to lines of business and treaty layers that Munich Re has access to.

As detailed elsewhere in this article, Munich Re is denominated in euros and sports a dividend which was only lowered once (in 1969) since 1952. Swiss Re is currently trading on a multiple of 7.4 for 2012 with a yield of 6.9%, and Hannover Re is sporting a multiple of 6.5 and a yield of 6.2% for 2012. The multiple for Munich Re is just 6.0 and the yield is 7.48%. (All forecasts derived from www.digitallook.com.)

Munich Re’s integrated business model covers large sections of the value chain in the risk market and the group leverage synergies in revenue and costs whilst reducing the risk-based capital requirement through better diversification.

The following table shows the largest five companies categorized by net reinsurance premiums written:



Company


Country


Net Reinsurance premiums Written (US$ billion) in 2010


Munich Re


Germany


29,269


Swiss Re


Switzerland


19,433


General Re


USA


14,669


Hannover Re


Germany


13,653


Lloyds


UK


9,762




Of the main listed reinsurance companies, Munich Re weathered the 2007/9 storm the best. Swiss Re needed a capital injection of around US$2.6 billion which was provided by Warren Buffett after Buffett bought a 3% stake in Swiss Re during 2007/8. In addition, at the same time, Buffett made a deal with Swiss Re that Berkshire Hathaway, of which Buffett is chairman, would receive 20% of property-casualty premiums for the next five years whilst incurring the same risk.

Furthermore in comparison of Swiss Re and Munich Re, since both have Buffett on the register, the German dividend withholding tax is 27% against 35% for Switzerland.

Terrible Year and the Future

2011 realized Munich Re's fears by providing the company with its worst operational year ever. The Japanese floods and tsunami together with Australian floods heralded a tough start to the year with tornadoes in the U.S. having a large impact on underwriting as well. Further catastrophes, such as floods in Thailand and an earthquake in Turkey, continue to depress profits. However, the group expects to make a profit for the current year subject to more catastrophes occurring. The dividend for 2011 is likely to remain stable from 2010 when the payout equaled €6.25 per share.

Natural catastrophes are not the only fly in the ointment at Munich Re. The current economic turmoil is affecting the investment result. For example, Munich Re wrote down €1 billion on Greek bonds, low interest rates continue to hamper returns and Italian bonds were reduced by €1.4 billion presumably at a loss. The discrepancy between yields on stronger sovereigns and peripheral countries within the eurozone shows that uncertainty is ongoing. For the first nine months of 2011 Munich Re’s investment returns are €4,815m (2010: €7,281m) or 3.3% annualised. However lower returns, under 4%, were forecast in the 2010 annual report. Corrected forecasts now stand at a return of just under 3.5% for 2011.

Of course Ergo, Munich Re’s primary insurance business, has also been featured in the press in less than favorable terms when it emerged that senior management and several intermediaries were taken on an incentive trip to Budapest in 2007 and rewarded with the services of prostitutes. These subjects were addressed head-on by Nikolaus Von Bomhard, Munich Re chairman, in the 2011 interim report.

So what will the future bring apart from uncertainty? Well it is a characteristic of (re)insurance companies to have a successful year after a bad year. The period following 9/11 is a prime example of this. When catastrophes occur (re)insurance companies can increase their prices in-line with the industry price increases (there is no real pricing power, outside of the industry, as the product is of a commodity type). However, a double whammy occurs as people become aware of these catastrophes and take out insurance. The result is an increase in volume and price which leads to a successful outcome for the (re)insurer.

For the current year till end of the third quarter the group made a net profit of €80m. The New Reinsurance Company Ltd. and Ergo paid dividends of €366m to Munich Re but were eliminated in the accounts due to the intra-group consolidation process.

Gross written premium income is expected to come in at approximately €49-€50 billion. Munich Re is forecasting a profitable end to 2011 for the year as a whole. The dividend is expected to remain stable at €6.25 per share.

Float

I am including this heading as I will be asked about Munich Re’s float in the comment section. Presently I am unable to calculate Munich Re’s float from the balance sheet. Over the last month I have asked many people for their calculation, after showing them mine, but I have not received one decent response.

For what it is worth my calculation is as follows:

Based on the 2010 Munich Re Annual Report:

Unearned Premiums (Reference C I on liability side of B/S) = € 7,879

Plus

Provisions (Reference C I & II under liabilities) = € 104,413 + € 49,501 = € 153,914

Plus

Other Technical Provisions (Reference C IV) = € 9,555 (not sure if I should include this line)

Total = € 171,348

Less

Net Deferred Acquisition Costs (Reference G on asset side) = € 9,093

Less

Deferred Tax Assets (Reference H) = € 5,959

Total = € 15,052

Therefore Float = € 171,348 less € 15,052 = € 156,296

This figure looks too high to me. Please comment below if you can calculate float from the balance sheet.

Munich Re's reply to my float calculation is as follows:



"Please understand that we cannot judge your calculation, since Warren E. Buffett’s “float” model is just one way of many others to evaluate a company, a partial reflection from only this perspective (no matter which figures one applies) distorts a fair and therefore applicable value. This better is represented by the consolidated cash flow statement and following commenting notes you can find in our annual report, page 156. Thank you for your attention."

Valuation

Dividend:

Munich Re’s share price was €83 today in Europe. Such a price will yield 7.53% if the 2010 dividend is maintained. Munich Re has raised or maintained the dividend since 1969. In fact 1969 is the only year in which there was a dividend reduction since 1952.

In conjunction with the dividend, Munich Re returns excess cash to shareholders via a share buyback scheme. The following table shows the weighted average number of outstanding shares:



Year


Number of Outstanding Shares


Q3 2011


177,588,750


2010


185,422,866


2009


194,692,459


2008


200,883,490


2007


215,328,152


2006


227,568,187


2005


228,201,627




As can be seen, over 22% of the outstanding shares have been repurchased over the last six years. Currently the repurchase programme is on hold due to the challenging year. Munich Re intends to resume the programme when appropriate.

Multiple and Equity (Book Value):

On current forecasts for 2012, Munich Re trades on a multiple of just 5.9.

Table of 2012 Forecasts:



Revenue (€ billion)


Pre-Tax Profit (€ billion)


EPS (€ cent)


Dividend (€ cent)


49.52


3.67


1,408.89


646.23




The average five-year earnings per share, from 2006-2010, for Munich Re weighs in at €13.326 per share which suggests that when placed on the five-year average multiple over the same period (9.52) we can calculate a fair value of €127. This figure suggests the shares are discounted from fair value by 35% (or inverting this there is 53% upside).

Furthermore, the share price is trading at a large discount to net asset value.

Historically the share price has traded above book value as shown below:



Year




Equity (€ billion)




Market Cap (€ billion)




Premium/(Discount)




2010




23




21.4




(6.95%)




2009




22.3




21.5




(3.58%)




2008




21.1




22.9




8.53%




2007




25.3




29.0




14.62%




2006




26.3




29.9




13.69%




2005




24.3




26.3




8.23%




2004




20.5




20.8




1.46%




2003




19.3




22.1




14.5%




2002




13.9




20.4




46.76%




2001




19.4




54.0




178.35%


Currently equity, taken from the third-quarter results equals €23.03 billion versus a market capitalization of €15 billion. This represents a discount of 35% to book value (or upside of over 50% to reach book value valuation). This mirrors the earnings valuation.

On page 55 of the 2010 annual report it states that assets which are traded on the capital markets are valued on the basis of the market values observed at the valuation date. A breakdown of asset valuation methods can be found on page 164 of the same report under the heading ‘B // Investments’. Fixed-interest security valuation methods are shown on page 165 with a detailed table covering all pricing methods on page 166. These pages are essential reading if working with the book value figure.

Based on the above valuation the shares could be termed a bargain. In "The Intelligent Investor," Benjamin Graham suggests "that an issue is not a true ‘bargain’ unless the indicated value is at least 50% more than the price" (p82, Portfolio Policy: The Positive Side).

The Oracle of Omaha

At the end of 2010 Warren Buffett owned a 10.244% stake in Munich Re broken down as follows:



%


Direct Holding


Indirect Holding


Warren Buffett


0.053


10.191


Berkshire Hathaway


10.191


OBHH LLC


10.191


National Indemnity Corp


10.191




According to a letter Buffett sent the company, the intention is to increase his passive shareholding in Munich Re throughout 2011.

Due to stock repurchases I estimate that Buffett’s holding at the end of 2010 (19,259,600 shares) is now worth 10.84% of the company. The estimated average purchase price of those shares is around €107 against a trading price of €83.50 at time of writing. Just last week Buffett mentioned that he is buying a European stock ‘today, tomorrow, next week and next month,’ at current prices my guess is that this share is Munich Re. However we will find out at the start of February, 2012.

Buffett’s presence on the share register brings forward an element of safety for smaller investors. Reinsurance companies insure each other through a process known as retrocession. This basically means that reinsurance companies have an interest in other reinsurance companies. Should Munich Re need capital aid then I am sure that Berkshire Hathaway, Buffett’s holding company, will come to the rescue. I hasten to add that Munich Re escaped the 2007/8/9 crash without any external aid unlike Swiss Re. In fact Munich Re proved to be the strongest (re)insurance company during this trying time.

Risks

The majority of risks for Munich Re echo those of other (re)insurance companies. These include underwriting risk which contains premium and reserve risks, market risk which includes equity, interest rate, currency and property risk, credit risk as well as operational, liquidity, strategic and reputational risks.

Risks are controlled, if possible, by a variety of committees. The Group Committee, Group Risk Committee, Group Investment Committee and the Reputational Risk Committee are all affective at group level. At segment level these include the Global Underwriting and Risk Committee, the ERGO Risk Committee and the Munich Health Risk committee.

The risk report starts on page 116 of the 2010 annual report which can be found on the Munich Re website listed below under the "Further Reading" heading.

Latest News

Munich Re subsidiary Windsor Health, which was acquired in October 2010, is set to create 80 jobs at two new offices in Atlanta, U.S. Sixty-five people will be employed at the executive offices in Buckhead whilst a further 15 people will gain employment in a satellite office in Duluth.

The above development is in line with Munich Re’s desire to grow the U.S. business by 40% over the next three years as U.S. profits grow at a higher rate. The U.S. makes up around a third of the company’s business so good growth is forecasted.

Conclusion

The prime valuation tool utilized should be the large discount to book value but of course other value measurements also work at these distressed prices. For example, the yield is historically high and the multiple is historically low. Munich Re is a very well-run machine which generates excess cash and has the backing of Warren Buffett.

Calendar

29-30th November: Roadshow Benelux

6th December: UBS ‘Senior Investor Day’, Munich

8-9th December: Roadshow Geneva/Zurich

9th December: Roadshow London/Zurich

2nd February: 2011 Preliminary Figures

26th April: AGM, Munich

27th April: Annual Dividend Payment

Further Reading

The Munich Re website can be found here:

http://www.munichre.com/en/homepage/default.aspx

For those interested in purchasing ADRs or gaining exposure to Munich Re from the U.S., please read the comments at the bottom of the following article:

http://www.gurufocus.com/news/133888/i-initiated-a-position-in-munich-re-at-almost-the-same-price-as-berkshire

There is an excellent article regarding float and Munich Re here:

http://www.theactuary.com/actuary/feature/2092013/insurance-float-valuations

Disclosure: Long Munich Re and am looking to add if the share price falls more.

About the author:

Liarspoker
Stockbroker @ www.market-swings.com

Visit Liarspoker's Website


Rating: 3.7/5 (17 votes)

Comments

Liarspoker
Liarspoker - 3 years ago


Just to add that I have just received answer from the company regarding how the European Solvency Requirements II will affect the company's asset base:

'since our risk model reflects all current Solvency II requirements (with a factor of 1,75 even beyond the standard) we do not need to raise additional capital.'

They then refer to the bottom slide on page 10 of the following presentation:

http://www.munichre.com/app_pages/www/@res/pdf/ir/publications/presentations/2011_10_05_banking_and_insurance_ceo_conference_en.pdf?1
marcolanaro
Marcolanaro - 3 years ago
Great article! I love the company too.

I use to measure success in insurance companies by their return on assets and cheapness by their P/BV ratio. Do you have any comment on that?

Liarspoker
Liarspoker - 3 years ago


Thanks for the compliment Marcolanaro. The price vs book value is the initial main factor I look at and as such I have labelled Munich Re a bargain stock ( according to Ben Grahams definition in the Intelligent Investor ) at a price of €83.50 according to this principle.

The article was actually ready earlier in the week but I was waiting for a few answers to questions I had from the company. The shares are trading at around €93 in Europe at the moment.

Regarding return on assets I mainly focus on investment returns which are somewhat hard to come by in the current environment. I plan to hold my Munich Re shares till a price of around €120 is reached depending on the performance of the company. This may come in 2012 or later but I'll be watching the investment returns in every quarterly report Munich Re releases.
marcolanaro
Marcolanaro - 3 years ago
I did buy at around €100 few months ago and lately I have been thinking of adding some more shares but since markets are quite irrationals I decided to put a buy order at €75, I suppose that it is too low.

Thank you for the answer.
Liarspoker
Liarspoker - 3 years ago


No Problem. I traded them successfully from the low €100's to around €115 a few times. I still hold a few bought at €104/5 but have been adding at around €92, €89 and €85. I was about to buy again at €83.50 but the market turned too fast. Ah well back to the patient game. :O)

shareladder
Shareladder - 3 years ago
Nice article Liars. I've been looking at the price action too but I don't hold as of yet. The interview with their CEO on bloomberg was interesting as he said he 'encouraged' catastrophes...more people and businesses will get insurance afterwards. Method in the madness there. Obviously if there are no hurricanes, floods, tsunamis, heatwaves, or gales then people will let insurances lapse.

Blow wind blow!
Liarspoker
Liarspoker - 3 years ago


Cheers Shareladder. The Bloomberg interview with the CFO can be found here:

http://www.bloomberg.com/video/79703752/
marcolanaro
Marcolanaro - 3 years ago
I found very interesting the last comment when the interviewer said that investors are concerned about the number of catastrophes happenning and the answer was that Munich Re exists and its business proposal is exactly about insuring those events happenning.
Liarspoker
Liarspoker - 3 years ago


Yes, Like I said in the article more people become risk aware when catastrophes occur and take out insurance therefore a larger amount of volume passes through the books the year after a badly affected year. (Re)insurers raise prices to provide a double whammy of volume increases and price increases.

When Buffett talks about lumpy results it's the insurance business that he is talking about.
mohmand
Mohmand - 2 years ago
Dumb question, what is the difference between MURGY and MURGF? I've noticed both available. Is there an ADR available?

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