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Jockey Angle: Admiral Group

December 02, 2013 | About:
Chandan Dubey

Chandan Dubey

99 followers

Admiral Group Plc (LSE:ADM) is a UK car insurance business, launched in 1993, run by “owner operator” management. A substantial amount of CEO’s net worth is invested alongside the shareholders and it is heartening to see an insurance company which cares about their customers.

The Group’s UK business has grown every year since its launch in 1993 and has 11% market share of private car insurance. It also owns one of the leading UK price comparison websites Confused.com. It owns price comparison websites in Spain, France and the USA too.

Key Figures:
All figures in GBP (£)
Combined Ratio: 84% (over the last 20 years i.e., 1993-2012)
Investments: 2B
Shares/Price/Cap: 274M/12,43/3.4B
Dividend/8Y CAGR: 7.2%/21.1%
Share price growth: 15.6% (Oct 2004 - Oct 2012)
Debt: 0

History
Henry Engelhardt, the CEO of Admiral, launched the company in 1993 after being headhunted by Lloyd’s.

:
"Everybody in the market was going after the good driver, the over 40s, the lower premium stuff. We thought we shouldn't try and compete with them head on and went after higher premium business, which is largely drivers under the age of 40." - Henry Engelhardt [insuranceage]

The car insurance business was run by brokers in those days. The percentage-based commission of brokers made the acquisition costs of the competitors higher, putting Admiral at an advantage with its fixed marketing costs.

In November 1999, Engelhardt lead a management buyout of the company. This resulted in a significant amount of management shareholding in the company. The CEO owns 13.6% of the shares outstanding, the COO David Stevens owns 3.9% and the chairman of the board Alastair Lyons holds another 0.18%. Together, they hold 17.68% of the shares outstanding.

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1997 Admiral launches two new brands: Diamond and Bell Direct.
1998 Launches commercial vehicle insurance intermediary Gladiator, on behalf of a panel of insurers.
1999 Management buy-out of Admiral at a time when the business was weak. Admiral also enters into coinsurance and reinsurance arrangements with Munich Re and Swiss Re. Both remain partner today. Munich Re also owns equity in Admiral.
2000 Admiral launches elephant.co.uk.
2002 Admiral launches UK’s first care insurance price comparison website Confused.com in the UK.
2004 Admiral goes public on LSE at £2.75 a share, with a market cap of £711M.
2005 Admiral launches MultiCar which enables UK customers to insure two or more cars on the same policy, with a discount.
2006 Admiral launches its first international foray. Balumba.es is opened in Seville, Spain. Admiral goes on to open AdmiralDirekt.de in Cologne, Germany (2007), Cone.it in Rome, Italy (2008), and Elephant Auto Insurance in Richmond, Virginia (2009).
2009 Launches Rastreator.com, a car insurance price comparison website in Spain. It also opens Inspop Technologies in India to provide the group IT support for its price comparison operations. It later opens Lelynx, a price comparison website in France (2010) and Chiarezza, another one for Italy.
2011 AdmiralDirekt.de is sold to Itzehoer Versicherung and Chiarezza to BlackFin Assurance Courtage.
2012 Admiral diversifies to UK household insurance. It has 13 brands, 3.6M insured vehicles and over 6.5K staff spread over eight countries.

Insurance and banking are probably two industries that are hardest to value or get a grip on. It is, hence, of utmost importance that the management is able, risk averse and has the confidence to go against the crowd when necessary. Most importantly, the management should behave like “owner operator” of the business and their incentives must be aligned with the shareholders.

Management
The significant shareholding of the management already aligns the incentive of the management towards the shareholders. Furthermore, Engelhardt does not belong to option plans. His salary of £373.7K is low by industry standards. Instead, he awards employees with share grants provided they reach prespecified targets.

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He has a refreshing view on acquisitions. They are not part of his plan. Admiral has not acquired a single company so far, instead they have sold a part of their business.

:
"To try and bite off RBSI ... is just one big step too far for us. We are getting it organically much cheaper than we would be paying for it so, in a sense, why bother?" - Henry Engelhardt [insuranceage]

Instead, he wants to grow in a profitable manner. He is determined to underwrite profitable insurance and avoid price cutting.

:
“We want to grow, but not by making a loss. We could double our policy holder growth by slashing our rates, but we don’t want to.”

The company remains risk averse with its float as well as balance sheet. It has no debt and all investments are in money market funds or government debt.
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The investment income, understandably, is quite small (£13.9M in 2012). The CEO sees this as an advantage for Admiral, especially in a hardened market. With interest rates at historical lows, its competitors have to raise their pricing to remain afloat.

:
"We are profitable as it stands. We don't need to match their rate increases so certainly some of our growth has been fuelled by not matching them," - Henry Engelhardt

During the 2009-2010 downturn, its competitors had to declare huge reserving increases. They blamed increased personal injury claims for the unprofitability of their business. Admiral was doing nothing of the sort and it remained profitable.

:
"It might be we were reserving more than they were three, four, five years ago. Perhaps they were not reserving appropriately and all of a sudden they got caught short?" - Henry Engelhardt

The truth is that Admiral is a low cost operator, as the following graph shows.
EVR_wOsUvHEubVBHrMVV_LOvunkOSk40BEj6FyH-

Henry Engelhardt has an unusual way of running his business. He does not distinguish between employees and the management. Admiral does not have special company cars (or jets) for the management. Even the chairs are the same. No wonder, the company was awarded best large UK workplace for the year 2012. Every new employee of the company gets a jigsaw piece when he joins.

:
“No one can really tell what the piece is. No individual makes the puzzle and ... everybody works together," - Henry Engelhardt

The year 2011 was a tough one for the company. The company had higher than expected claims and the share price lost 30% of its value. Fortunately, this was a bump and 2012 turned out to be an excellent year for Admiral with 15% higher pre-tax profits.
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:
“We have a simple philosophy at Admiral: if people like what they do, they’ll do it better. So we go out of our way to make this a good place to work. The result: happier staff, record profits.” -
Henry Engelhardt

Business
Insurance is a cyclical industry. As profitability improves and rate hardens, the greed to grow business at the expense of quality increases among insurers. They raise marketing, develop new offerings and lower prices to grow shares. This continues until the market realises that this is unprofitable business they are underwriting. They make losses, increase their reserves and raise their rates.

It makes good business sense to grow when the rates are increasing and most insurance companies are reeling from losses. It also makes sense to wind down and not chase the market when they are stepping over each other to cut rates. Discipline is the key.

:
“This is even more the case for a player such as Admiral that has a significant combined ratio advantage over the market as a whole and can, therefore, afford to raise rates less quickly than the market as a whole when the cycle turns up.” - Alastair Lyons, Chairman

Admiral worries about the downside. They abhor risk. This is evident from their conservative investment portfolio and the fact that 75% of their book is reinsure through coinsurance or quota share. When they enter a new market, they do so slowly and try to grow organically, instead of going around buying a bunch of companies.

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Admiral refuses to write business when they are unprofitable. The UK market this year is going through such a phase at the moment. Admiral competitors are cutting rates and writing new business.
iSfLhiDMXCCzN7HTlb51Q1TC5-Ga-XvEsQYvFOBK

The business has performed admirably. The book value per share has tripled in the last 10 years and the Return on Invested Capital has remained quite high, improving over the years. Last year it was almost 60%. During the same time EPS has increased almost 500% !
wbiBwcVRSfaeXIdPqUsBdCzku6pYufebfHEWJdhO

Risks
The CEO is one of the main reasons for the success of the company. Henry has no official date for leaving but he has mentioned that leaving is something he thinks about.

:
"I do believe that at a certain point in time a company needs change, it needs somebody new at the top, it needs some new ideas, it needs a fresh way of looking at things and doing things and I'm becoming stale."

In 2012, Admiral made £170.9M from ancillary sales by for example extracting fees for alerting car hire firms of accidents, giving leads to rival insurers when losing business etc [telegraph]. Regulatory and legal changes may prevent Admiral from collecting these fee.

There has been significant regulatory changes already. Personal injury referral fees will be banned from 1 April 2013. Admiral earned £18.6M from this fee in 2012. Additionally, Admiral earned £13.6M from vehicle in credit hire referral fees, which might be banned by UK Competition Commission.

To better manage the risk, Admiral uses coinsurance and reinsurance to reduce its own capital requirement. This lets it invest the capital in the business, increasing the return on capital employed. If this support is unavailable, Admiral may need to keep higher reserves.

Claims of personal injury have increased drastically in the UK. The claims of whiplash injuries alone amounted to £2B in 2012, or £90 per insurance premium [admiral]. Questionable personal injury claims are partly to blame.
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Valuation
Admiral is trading at 1.4 times its investments of $2B and 13 times its peak earnings. It also sports a dividend yield of 7.2%. I don’t feel that it is very cheap.
There is a lot of potential for international growth. If Admiral can transfer its cost effective strategy to Spain, Italy, France and US -- there will be significant upside in the EPS and revenue.
The price comparison website is also very profitable with £18.2M profit in 2012.

Discussion
This could have been a great candidate for a long term investment. Unfortunately, there is one very serious problem with the thesis.

Most of the income is made of commissions, and ancillary revenue. This is not unique to Admiral. The regulation clearly is going against these practices. It is not clear if the group can maintain similar amount of profitability otherwise.

Given that the stock is fully priced, maybe even expensive, I don’t feel that I have the necessary margin of safety to justify an investment.

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.2/5 (11 votes)

Voters:

Comments

Tannor
Tannor premium member - 10 months ago
Awesome write-up Chandan,

I had not heard of this company before reading your article but you definitely have me intrigued. Those are phenomenal numbers (Combined Ratio, Expense Ratio, ROIC) and as you noted they are clearly a low cost producer. My one question is how do they outperform peers by such a vast margin in regards to the low expenses?

Cheers,
cdubey
Cdubey - 10 months ago
1. There is no broker involved, they only sell through their website and confused.com -- which they own. 2. They sell to the younger and the riskier crowd, which has higher premiums. 3. They also sell add-ons, like lawyer protection on the same insurance. 4. Everyone in the company has the same desk and the management does not get even cars -- this should tell you something about the culture of the company. They clearly watch their expenses. 5. When the customers leave, they refer them to other insurance companies. 6. When there is an accident, they know about it immediately. They then pass this information to the car renting companies. Combine these and that would explain probably 7-8% better margins. They clearly have higher margins and I will need to dig deeper for that.
Tannor
Tannor premium member - 10 months ago
Awesome thanks.

1, 4 & 5 are most likely the significant factors and this company reminds me of the GEICO business model. The very low expenses also would contribute to the a higher combined ratio, they must have a very great underwriting and actuary team, as depicted by your reference in (2) and the following quote.

"Everybody in the market was going after the good driver, the over 40s, the lower premium stuff. We thought we shouldn't try and compete with them head on and went after higher premium business, which is largely drivers under the age of 40." - Henry Engelhardt

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