Recent market highs have pushed the “great companies at fair prices” narrative to extremes, with any above-average growth company at 30x earnings multiple labelled as compounder. But is it possible to join the “compounder-club-bro” without paying hefty prices? you get the chance to do just that with Protector Forsikring, a small Norwegian P&C insurer (Market cap 5.9B NOK) which has fallen out of investor’s favor over the past few months.
Protector gets the “compounder” title from its impressive 22.4% IRR since its Oslo IPO in May 2007. However, this IRR was much higher 3 years ago (~32%) as the share price has essentially been flat over that period (adjusted for dividends). With an historical average combined ratio of 92%, Protector was getting paid 8% a year to hold its costumers’ money; investing in this float has yielded another 7% per annum, while the entire pie has grown >20% per year. This is compounding at its best.
We believe Protector will be a multi-bagger from here over the next 5+ years. For this to come true, short-term underwriting issues will need to be proven transitory and Protector will need to strengthen its cost advantage to maintain rapid growth rates. This is far from guaranteed - but the risk/reward is highly favourable, valuation is attractive, management is well incentivized, and the business model has worked well over the past decade.
Protector currently trades for 10.3x/8.5x P/E on 2019/2020 consensus estimates. That is very cheap and highly unusual in the current market for any company, let alone one which still grows top line 20% annually. There are legitimate questions regarding the sustainability of these estimates given that most of Protector’s earnings are investment gains coming from the managed float+equity. These tend to be very volatile and market-dependent, and hence hard to forecast. So like with any insurance company, what we wish to estimate are normalised CR, growth and investment returns. we can expect 2018 normalized earnings to look something like this:
NOK 3.5b of Net Written Premiums @ 95% Combined Ratio → NOK 175m
NOK 10b of AUM (82% fixed income and 18% equities) @4% return → NOK 400m
Each of the assumptions embedded above is worthy of further discussion and it’s likely that 2018 earnings will in fact diverge significantly from this number. However, on a normalized basis I think they’re fairly conservative assumptions and illustrate the inexpensive valuation.
Based in Norway, but operates throughout Scandinavia and as well as the UK, Protector Forsikring tagged itself as “The Challenger” of the Scandinavian insurance industry. With a lean cost structure and internally built IT systems, the company was able to create a competitive advantage in the form of industry-leading cost ratio, despite significantly lower scale than comps. The company prides itself as the lowest cost-ratio insurer worldwide. We didn’t verify that claim - but the company certainly has a leading position among Scandinavian insurers, which as a group has cost leadership compared with most European peers.
Management likes to point out its internally developed IT systems as a major contributor to this lean cost structure, but we believe culture plays a bigger role here. Protector simply does more with less, and chooses its battles carefully. With a “build-it-right-from-start” approach, Protector has avoided the competitive spheres and concentrates its efforts on niches where management believes labour intensity is low and ROI is highest. The business model is based on serving the public sector, where Protector is already the industry leader in Norway and Sweden, and providing commercial insurance for medium and large companies (they also have a segment called Change of Ownership insurance, which is now a smaller part of the overall business). Interestingly, the company does not sell insurance directly and instead conducts business via brokers. This may surprise some who automatically drew an analogy to Geico or Admiral group, but Protector is a different breed and has developed by deploying its own strategy, rather than replicating someone else’s path.
Working solely with brokers arms the company the following abilities:
Penetrate the public sector in new countries much quicker, putting its foot in the door for the commercial sector.
Become the preferred insurer for most brokers (as unlike most insurance companies, they don’t compete with their own brokers).
Keep operations lean and headcount low - concentrating recruitment to a small group of “all-stars”.
Below is a comparison of gross expenses ratio as presented by the company. I would note that by staying away from retail insurance, which is usually labor intensive and has lower claims ratio as a compensation, makes the comparison less precise:
Leveraging this cost advantage, Protector has been able to offer attractive prices, grow at very attractive rates, and handle claims swiftly. In an industry operating in a 85%-90% combined ratio, this means that even with aggressive pricing Protector can profitability underwrite most insurance products.
The company started operations in Norway in 2004, expended to Sweden in 2011 and Denmark in 2012. More recently, the company expanded to Finland and the UK in 2015-2016, where most of current growth is coming from. While the phenomenal growth in the UK increases geographical diversification, its main potential lies in scope. Just to get a sense of scale - Scandinavia has ~25m people and ~1T of GDP. UK alone has a population of 65m and a GDP of ~2.6T. The decision to choose the UK as the first expansion target outside Scandinavia wasn’t taken lightly. Management put in two years of research trying to figure out which adjacent markets are most attractive to new entrants in general, and which are most suitable to Protector’s strategy in particular. Protector entered the UK market in 2016 but only started growing aggressively last year. Over the next few years the UK is expected to be the fastest growing region for the company, and management believes that their relevant TAM in the country is as large as their current markets in Scandinavia combined (while sticking to their strategy of only targeting the public sector and commercial lines where they could relatively quickly take #1 or #2 spot). Below are some slides from the company’s 2017 capital markets day that go through the process behind the decision to enter the UK.