Admiral-Report by wanghonghx


									Students of Bath Investment Club

  Investment Research Report
Admiral Group Research Report
4th March 2012
Tom Shaw Carveth
Tommy Dai
Andrew Hunt
Charles Wong

Admiral Group plc                                                                 Sector:
Executive Summary
                                                                                  Car Insurance
Over the past 10 years Admiral Group has been a top performer in the car
insurance market. Admiral’s share price rose consistently since IPO, driven       Market Capitalisation:
by increasing revenues, profits and dividends. These achievements always          £2,860m
exceeded analyst expectations. 2011 saw a re-evaluation of expectations as
regulations, increasing claims and a possible stagnation of premiums              Share Price: 1059p(4/03/12)
resulted in Admiral stating they would not meet market expectations for           Index: FTSE 100
FY2011 profit. The share price was one of the worst performers of the year
and although profits were still expected to be higher than the previous year
Admiral’s share price fell around 40% for the days around the                     Current P/E: 12.95
announcement. SOBIC began investigating whether this provided an
appropriate buying opportunity. The CEO and other directors also began
                                                                                  Current Div Yield: 5.18%
buying shares following the large falls. Admiral has numerous issues to deal
with but the company Directors clearly still believe that the low-cost            FY10 PBT: £266m
competitive advantage will continue to provide strong returns.
Our meeting with Louise O’Shea (Head of Investor Relations) and Rhodri            1H11 PBT: £161m
Tilsley (Finance Department) took place on 23rd February 2pm at Admiral’s
HQ at Capital Tower in central Cardiff.

Company Description
Admiral Group is one of the UK’s largest private car insurers based in Cardiff,
Wales with four brands: Admiral, Bell, Diamond, and Elephant. In addition,
Admiral Group own, a leading price-comparison website
specialising in insurance and financial services. With average revenue
growth of 33% since its inception in 1990 and high dividend yields, the
strong, sustainable growth and financial performance that Admiral Group
has enjoyed thus far provided a strong platform for investment.
Admiral has rapidly gained market share in the car insurance market over
the last 20 years. It is now looking to expand in other countries such as
France, Italy, Spain and the US. Currently these businesses are small but
they could grow to become a significant part of Admiral’s business model.
A key part of Admiral Group’s strategy is the customer procurement
through price comparison websites. This was pioneered by the Admiral
subsidiary which controls a significant share (around 30%) of
the car insurance price comparison market. Although rival websites have
gained market share, Admiral group still receives the majority of customers
through this avenue, whether through or rivals. Admiral is
very competitive on price comparison websites as it is a low-cost provider of

Historic Share Price:
Company History
The current CEO Henry Engelhardt successfully completed a management
buy-out in 1999 where the insurer spun-off from the holding group. In 2004
Admiral floated on the London Stock Exchange with a market capitalisation
of £711m. Admiral initially targeted high premium customers such as young
drivers, sports car drivers and previously convicted drivers. As Admiral has
expanded this target market has widened and Admiral is now a low cost
mass market car insurer. Admiral’s share price increased to reflect its
successful performance in the industry and the growing expectations of
investors. 2011 has been a more difficult year. Although profits remain
high, issues such as increasing claims, the threat of competition, increased
regulatory involvement in the industry, reducing premiums growth and
fears of a reducing impact of the competitive advantage in the UK have
seen a re-evaluation of Admiral Group’s share price.

Key positive points
The first fundamental strength of Admiral is its employee’s belief in the
success of the company. This is shown directly from the high employee
ownership of the firm; 25% Director owned with a recent £11m share
purchase, £7m from the CEO. As seen from 2010’s financial statements, this       Admiral Group CEO Henry Englehardt
belief is well grounded. With a pre-tax profit margin of 16.75%, return on
capital of 59% (up 5% from 2009) and holding zero debt, the financial
performance of Admiral is very strong. As such the firm can afford to have a
policy of distribution of a minimum of 45% of post-tax earnings as
dividends. Further to this, 2010 post-tax distributions totalled 94% which is
a strong indication of Admiral’s current financial performance and intention
to reward shareholders. Key to this performance is a consistent average
revenue growth of 33% since 1990 albeit current projections are lower at
15% revenue growth; however, this still enforces Admiral’s core strength.
Driving Admiral’s revenue growth is their sole strategy of vehicle insurance;
car insurance provides 90% of revenue. This allows the firm to concentrate
all its resources to develop cost advantages and lower prices compared to
its competitors, such as RBSi, which have a broader range. Admiral has
developed a low cost corporate structure which is less bureaucratic and
more efficient in terms of the pricing of risk. Also, Admiral underwrites only
25% and 75% is reinsured; the company has agreed to extend their
reinsurance partnerships with various firms such as Hannover Re in
addition to an existing agreement with Munich Re at no cost change. This
strategy allows Admiral to grow and distribute more funds to shareholders.
The news of the extension of reinsurance agreements at no additional cost
was positive and resulted in a share price increase. Some investors were
fearful that the cost of reinsurance would increase as claims were
increasing; the news confirmed this was not the case.
Furthermore, Admiral has a significant market share (~30%) in the internet
price comparison market (through subsidiary which allows
the company to take advantage of the unique characteristic of the UK
market where 33% of customers switch insurance each year. Furthermore,
the fact that car insurance is a commodity product and a legal requirement
allows Admiral to funnel these market characteristics to their comparison
site and benefit from the firm being a low cost provider of insurance.
Key positive points (cont.)
Admiral has also embarked on a conservative expansion into international
markets, in particular, France, Spain, Italy, US and Germany. Due to the
differences in international dynamics and competition, not all these
ventures have been successful, such as Germany. However, it must be
noted, to Admiral’s credit, that after only a cost of £10m, the group has
pulled out of Germany. Meanwhile, Spain has broken into profit. These
factors indicate that Admiral can tap into international markets whilst
maintaing very good risk management.

                                                                               Admiral’s International revenue only
                                                                               accounts for 5% of total revenue.
                                                                               However, the interim report showed
                                                                               that international revenue increased
                                                                               by 45% against the previous year’s
                                                                               interim figures.

Admiral offers one key product: vehicle insurance. Although this has
expanded into vans, it is car insurance that provides 90% of revenue. Many
other rivals are part of larger groups such as RBSI, Aviva, AXA and RSA.
Admiral has car insurance at the centre of its operations, this focus on the
core is very important as it allows Admiral to achieve cost advantages over
rival firms. Additionally, it means that all of the firm’s resources are
concentrated on successfully marketing, pricing and operating Admiral Car
                                                                                 Admiral’s Subsidiary: is a subsidiary of Admiral which provides insurance
comparison web services to online users looking to switch insurance policy.
It is suitable for the UK market where the consumers regularly switch
providers to cheaper options. This industry has expanded and is now more
competitive and intensely marketed. was once the largest
car insurance comparison website, however its market share has been
eroded by newer websites such as, and has slipped
down the rankings to 4th as these rivals have achieved market share gains
through intensive advertising. However, this expansion of the market has
suited Admiral as a low cost provider. Many customers which switch will
ultimately use Admiral regardless of which comparison site is used.
However, it remains beneficial for Admiral to link with as it
means Admiral has free access to the price comparison website, whereas
they have to pay fees for the rival comparison sites.
The car insurance market has begun to attract government and legislature
interest as the cost of insurance has increased greatly over the past few years.
This is driven by increasing claims and increasing payout for medical costs.
Admiral has ridden this wave and has achieved significant profits.

The market is expected to flatten driven by reduced car demand and also
increased competition – particularly from RBSI. Operating in a market where
rates and volume only increase by small amounts makes Admiral less
attractive and sales growth will slow. An additional consideration is the
government involvement. The government is trying to reduce the cost of
insurance and also the claims culture in the UK. To do this they are planning to
ban referral fees. These are fees paid to insurers by lawyers to gain
information regarding customers or a particular claim. No date has been set
for the implementation of the ban, but it is expected to come into force in
2013. The possible effects are:                                                       RBSI Brands:
  • A reduction in referral income for Admiral. This currently makes up 5-6%
of income and this will be lost if legislation is passed.
  • A reduction in the number of claims as lawyers have reduced information
to file a claim
  • A reduction in the rivals’ income as they also lose the income, this could
drive premiums up as the market as a whole will increase prices to take into
account this lost income.
  • A reduction in premium prices as fewer claims are made.
                                                                                     Other Competitors:
Admiral control 11% of the car insurance market. The leading competitor is
RBSI (RBS Insurance) who operate through the brands Churchill and Direct
Line. Aviva is next largest, with a similar market presence as Admiral.
Following this the market is competitive with competition from Esure, RSA
(More Than), LV, AXA and Hastings.
A threat could come from the proposed IPOs of a lot of these businesses,
including RBSI. Although this could indicate that their attention may move
away from the marketplace they may also begin to invest in marketing and
begin pricing competitively to give the impression to future investors that they
are growing. This increased future competition could be an issue for Admiral.
Admiral however is the only listed car insurer and the only large company
which focuses entirely on insurance for cars. This focus on the core activity is a
reason why Admiral can reduce bureaucracy, maintain a flatter structure and
be more flexible to changing environment. Admiral has a clear cost advantage.
Many of the other competitors are struggling to make profit and are only
breaking even by releasing reserves or by relying on referral income.
Admiral’s Cost Advantage
Admiral has achieved returns on equity and profit margins significantly above the market average. This is due to
Admiral having a cost advantage which is emphasised by the company remaining streamlined and focused entirely
on car insurance. These two features combined have allowed Admiral to outperform and is their competitive
Admiral maintains a low cost structure compared to rivals. They have achieved this through locating operations in
South Wales. From a rental perceptive this is advantageous and also the wage rate is lower. Generally Admiral is
able to pay staff less, yet they have a strong culture and good morale. This is maintained by Admiral investing in HR
and generally looking after their employees. Admiral was included in “Sunday Times 100 Best Companies to Work
For 2011” and “Best Workplaces 2011”, this area is of clear importance to Admiral. Additionally, Admiral is 25%
owned by employees, share ownership is emphasised by management and means cash wages can be reduced.
Admiral is successfully motivating staff whilst maintaining a low cost structure. From the2010 Annual Report 94% of
staff would recommend Admiral as a good place to work and 89% believe morale is high at Admiral. An initial
concern was in regards to how successful staff could be maintained and not be tempted by higher paying rivals.
However, this is somewhat offset by the positive culture and high morale. Additionally, car insurance is now
generally data entry and customer service as opposed to labour intensive and skilled fundamental actuarial and
underwriting work. Nevertheless, with this in mind, the threat of being unable to attract and keep key employees
remains a consideration. This is especially relevant when the share price goes through periods of low growth and
employees are demotivated by the falling returns from the share plan.
To supplement this cost-saving approach Admiral maintains a streamlined structure. Being focused on UK Car
Insurance and not being part of a larger or international group means that bureaucracy can be removed. The Head
of Investor relations also believes that middle management has been removed where possible to enhance
communication and reduce costs.

Key Risks
The current economic situation in the UK is not the best environment to operate a business. However, car
insurance, and particularly Admiral, is somewhat sheltered from this. Admiral is a low cost provider so as monetary
concerns enter the minds of the population customers may begin to trade down to lower cost providers using price
comparison sites. This will benefit Admiral.
On the other hand the reduction of cars and increasing unemployment will reduce the number of insurance
contracts written. This will reduce volumes and premiums.
Claims are considered the main risk and the main drag on Admiral’s share price over last year. Some analysts are
worried that Admiral’s portfolio is particularly risky and susceptible to the high value claims. They believe that the
previous low costs attracted higher risk individuals. The increase in claims value means that Admiral will have to
hold more back in reserves and incur increased costs. This uncertainty and projected lower profits provides
downside risk for the stock.
Referral fee ban is the first attempt by the government to curb the “compensation culture” and reduce insurance
premiums. When the regulation is implemented personal injury details will no longer be sold by insurance
companies to lawyers. This means that claimants will have a reduced incentive to sue as the chance of winning is
reduced. Referrals are said to encourage personal injury claims such as whiplash. Currently accident victims are
being approached to make claims by cold-calling injury lawyers who have purchased the accident details. This ban
could reduce claims and therefore reduce the premiums, whilst insurers’ margins would also be maintained.
The government is also planning to stop losing defendants having to pay a "success fee" to reimburse the claimant's
lawyer for unconnected cases he may have lost. The government proposals mean people making the claim will have
to pay the success fee, which will be capped, rather than the defendant.
Generally the government’s attempts to reduce claims and insurance costs are targeted at the lawyers as opposed
to the insurers. This is most likely due to the lawyers making large profits whereas the insurers are generally just
breaking even. These proposals are neutral to Admiral but in the future could be more damaging.
Financial Analysis
Admiral has an impressive track record financially. The below graph shows the impressive revenue growth over the
past 5 years, a CAGR of 19% (2005-2011). 2011 H1 has also seen an impressive 43% growth compared to 2010 H1.
Revenue growth has been driven by increases in market share and rising premiums.


In terms of profitability, Admiral has been equally impressive. Admiral has kept costs under control and achieved net
profit margins of around 30% for the past few years. Net income has grown at a CAGR of 18% (2005-2011). This
level of growth has outperformed rivals and expectations, this has driven share price over the past few years. If this
performance is maintained then Admiral will continue to be an excellent investment. The revenue growth in H1
2011 was impressive but was not matched by profit levels in the same period, which grew at 12.5% compared to the
period 12 months earlier. This highlights the impact increasing claims are having on profitability. It is also a concern
that Admiral is increasing customers during this period. It may be that rivals are cutting back their exposure whereas
Admiral are still pricing aggressively. This could cause considerable long-term problems in terms of a less desirable
insurance portfolio which is more susceptible the claims.
Financial Analysis (cont.)
The below chart highlights the rising importance of claims on Admiral’s business. Claims have increased significantly
over the past years and this hits profitability. 2011 H1 saw a 94% increase compared to the same period a year later.
Admiral are unsure of the reasons behind this sudden increase, it may just be random. However, the general
increase over the past few years is a result of a developing claims culture in the UK. This is driven by injury lawyers
and also possibly the harsher economic climate resulting in more of an incentive to claim. The UK Government are
putting in place measure to try and moderate the claims culture – a ban on referral fees is part of this process. A key
part of determining the future profitability is in regards to whether these claims will continue to increase, whether
Admiral has a particularly susceptible client base and whether the increase in revenue in 2011 H1 was attracting
clients who were more likely to suffer personal injury (the key claim driving the increases).

Additionally, Admiral has an increased reliance on reinsurance of claims. There were worries that the cost of this
reinsurance would increase in light of the increasing claims, however this was confirmed not to be the case.




       from        42%

Admiral has maintained an exceptional Return on Equity over the past few years. Rarely falling below 50%. This has
been achieved without leverage and highlights how impressive the performance of Admiral is. It is also the result of
a generous dividend policy which means that Admiral is running on a lean capital base and returning cash to
shareholders. The below chart shows the previous dividends of Admiral. The company states a dividend policy of
45% of profits, however if they feel that the company does not need the money then they are happy to pay out to
shareholders in the form of a dividend. Payout has been around 80%-90%, therefore the long-term sustainability of
this dividend growth is questionable.

Financial Analysis (cont.)
Other considerations and abnormalities in accounts.
Analysing Admiral Group’s 2011 interim balance sheet the majority of assets are in the form of Cash (£281m),
Reinsurance Assets (£479m) and Financial Assets (£1,319m, of which £579 are AAA investments, £303m are
deposits and £436m are receivables owed by policyholders). Admiral has low equity, due to high payout ratios, and
no debt. Current liabilities consist of Insurance contracts - claims (£1,084m) and Trade payables (£748m, mainly to

The key changes to the balance sheet since the last reporting period are:
1. Reinsurance assets have increased 70%. This is consistent with Admiral’s increasing insurance book and also the
increasing claims. Admiral recovers a large portion of claims from reinsurers so the receivables increases.
2. Trade and other receivables, including from policyholders increased 60% over 12 months to 30 June 2011. This is
consistent with the increase in trade for Admiral.
3. Trade and other payables, increased 83% this comprises largely of fees to reinsurers. The increase is consistent
with the increasing revenue and also increased reliance on reinsurers.

Excessive growth is expected for a further 3 years as Admiral is well managed, the lowest pricer of insurance and
expanding out to Europe and US. However, Admiral is beginning to reach maturity in the UK insurance market and
may see little substantial future growth in the domestic market. There is also the possible problem of competitors
pricing more aggressively.

Digitallook Forecasts:
Digitallook Broker Views:
Brokers are largely neutral about Admiral. There is no consensus in regards to the prospects for the company.
Investec are the most bearish broker.
Discounted Cash Flow

Below shows a Discounted Cash Flow model which is set roughly to the current value of Admiral (£2,860m). The
model shows what the variables would need to be to justify the current valuation. Admiral is entirely financed by
equity. Below are the assumptions regarding the cost of equity.

Cost of Equity (CAPM):
Beta ~0.7 (Bloomberg and FT)
5 year government bonds = 0.96%
Risk Premium = 8%
Cost of Equity = 6.56%

                                                      2011          2012          2013           2014          2015
Revenue Growth rate                                    12%           10%            9%             8%            7%
Net Revenue (£m)                                      717.7         789.5         860.5          929.4         994.4
Operating Costs %                                      60%           61%           62%            63%           63%
Operating Costs (£m)                                  430.6         481.6         533.5          585.5         626.5
Operating Profit (£m)                                 287.1         307.9         327.0          343.9         367.9
Tax % of Operating profit                              28%           28%           28%            28%           28%
Tax (£m)                                              80.4          86.2          91.6           96.3          103.0
After tax profit (£m)                                 206.7         221.7         235.4          247.6         264.9
Net Investment % of Net revenue                       0.9%          0.9%          0.9%           0.9%          0.9%
Net Investment (£m)                                    6.5           7.1           7.7            8.4           8.9
Working Capital                                         11            11            11             11            11
Change in working capital (Will leave at 0 as
relatively random)                                      0             0             0              0             0
Net Cash Flow                                         200.2         214.6         227.7          239.2         256.0
Cash Flow growth rate                                 -0.2%         7.2%          6.1%           5.1%          7.0%
PV of Cash flows                                      187.9         201.4         200.5          197.7         198.5

Terminal Value (Using exit multiple model)              2138.5 Assumes current PE would be same in 5 years to
                                                               calculate a terminal value (note: this amount is
                                                               roughly the same value as a zero-growth perpetuity
                                                               when r=7%)
Fair value of Admiral Equity (£m)                       2936.6
Fair value per share (£)                                 10.86
   Valuation (cont.)
   Dividend Growth
   Using the dividend discount model we can attempt to value Admiral based on expectations on future dividends. A
   key consideration for Admiral is in regards to the sustainability of the dividend. Admiral has a very high payout ratio,
   this leaves the dividend more susceptible to downside.
   The below model uses the 2010 dividend of £164m and then applies the Gordon Growth Model valuation technique
   based on the below variables.

   Highlighted in green are the variables which would give Admiral a positive valuation.

   Current Market Value £2,860m

                  Long-term dividend growth
                 0%         1%        2%        3%        4%        5%        6%        7%         8%
       5%      3294       4159      5600      8482     17129
       6%      2745       3327      4200      5655      8564     17294
       7%      2353       2772      3360      4241      5710      8647     17458

       8%      2059       2376      2800      3393      4282      5765      8729     17623
       9%      1830       2079      2400      2827      3426      4323      5819      8811     17788
       10%     1647       1848      2100      2423      2855      3459      4365      5874       8894
       11%     1497       1663      1867      2121      2447      2882      3492      4406       5929
       12%     1373       1512      1680      1885      2141      2471      2910      3525       4447

   As you can see the market is currently not pricing in much future growth for Admiral. Unfortunately there are not
   comparables for us to take a relative valuation approach for Admiral.

To top