Cape Town - An equity specialist on Thursday soothed Old Mutual [JSE:OML]
investors’ fears that the financial services giant may be experiencing cash flow problems after a downgrade by Credit Suisse last Friday.
Business Day reported on Monday that Credit Suisse has downgraded its rating of Old Mutual from neutral to underperform, mainly citing concern about the insurer’s ability to return cash to shareholders even after completing restructuring.
According to the report the downgrade contrasts with a recent bullish review of the South African insurer’s prospects by analysts at Nomura, who said Old Mutual was best placed among its domestic peers to benefit from growth opportunities in Africa.
Asked about what the downgrade means for shareholders, Asheen Rabilal, listed property equity analyst and assistant portfolio manager at SIM, said Old Mutual has already experienced strong outperformance and re-rating, on a total return basis:
• For the year to date (about 20% outperformance relative to the All-share index);
• Since announcing the sale of the Nordic business on December 15 2011 (about 40% outperformance relative to the All-share index); and
• Since its March 2009 lows (about 115% outperformance relative to the All-share index).
“Typically such strong outperformance is a good initial screen that a share may be approaching fair or even expensive levels.
"However, despite this strong relative performance, Old Mutual still has upside,” Rabilal said, citing the following:
• It still trades at a 23% discount to current estimated market consistent embedded value (MCEV ), where MCEV or embedded value is a good initial benchmark for an insurer’s valuation.
• Given that its listed Nedbank Group [JSE:NED]
holding makes up more than 40% of Old Mutual’s market capitalisation, it means the discount to MCEV of the rump or remaining operations excluding Nedbank at market value, is closer to a 35% MCEV discount.
• One could go further still and estimate what the market is currently paying for the offshore operations, by placing a fair value on the better quality South African life, asset management and short-term insurance business and carrying the Nedbank holding at market value.
The implied market price of the offshore is less than 20% of carrying MCEV on this basis.
Rabilal said these points show that there is still a good margin of safety in the share.
Another key metric is obviously the dividend yield, which at 2.9% currently looks quite depressed for Old Mutual.
However, the business is generating free cash flow that far exceeds existing dividend levels, he said, pointing out that the business is currently well capitalised with an FGD* (financial group directive) surplus of £2.3bn (168% coverage), so there is no requirement or need at this stage to shore up capital by retaining cash flow.
Furthermore, said Rabilal, “operating cash flow is not required at all to fund (Old Mutual's) 2012 debt reduction target, as they are on course to fully meet the target through use of the remaining proceeds from the Nordic sale”.
Given its programme of divestments and simplifying over the past few years (sale of US Life, Nordic, some USAM affiliates and failed sale of Nedbank), it is highly unlikely that Old Mutual will look to make material acquisitions at this stage, added Rabilal.
He said the remaining potential applications of the excess cash flow are share buybacks or materially increased ordinary dividends on the back of higher payout ratios.
“Either will lend support to the share’s rating, but management have indicated to the market that they will prefer dividends to share buybacks.”
Rabilal also said that the run-off of Old Mutual's Bermuda business is progressing better than expected, with surrenders exceeding assumptions.
“Because much of the legacy Bermuda policies offered guarantees to policyholders, it is a very capital intensive business. Higher surrenders than expected will allow for a quicker release of capital from this business,” he said.
Meanwhile, Investec on Wednesday reaffirmed its hold rating on Old Mutual, saying it currently has a $2.82 (R24.22) price target on the stock.
A number of other firms have also recently commented on Old Mutual.
In late August, analysts at JPMorgan Chase reiterated an overweight rating on Old Mutual shares and two weeks ago analysts at Alpha Value reiterated a reduce rating on the shares.
The two groups’ target price on the share was set at $3.05 (R26.20) and $2.56 (R22.00) respectively.
On Thursday, Old Mutual shares closed up 1.43% at R22.66 on the JSE.
*According to Old Mutual’s investor dictionary FGD is a financial regime applying to EU-based companies whose activities span both the banking and investment sectors and the insurance sector.
It lays down requirements for the company's capital positions and is intended to improve the stability of the financial system, thereby protecting customers.
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