After a couple of months urging from a colleague, I finally had a good look at CBL CORP FPO NZX (ASX: CBL), a New Zealand-based insurer. I decided I really liked the company, and bought a 2% position in it at $3.50 in early January.
Shares promptly dived 20% on no news and, after first reviewing my thesis to see if I’d missed something, I got greedy and bought another 4%.
What I bought:
Although CBL offers a wide variety of niche insurance products, most of the money comes from various types of building insurance:
Decennial Liability and Dommages Ouvrage are common insurance European products that protect against structural defects in a building for up to 10 years after construction. Decennial Liability insurance is mandatory in France, providing a strong market for CBL, which – with the recent acquisition of long-time partner SFS Insurance – will be the largest player in that market.
Other types of insurance provided are sureties of various kinds, including completion guarantees, which provide funding to ensure a building is finished if the builder goes bankrupt. There are also Property Deposit bonds, which are normally provided for houses or apartments under construction.
A buyer can pay a fee to CBL, which does due diligence on the applicant’s financial position, and provides a Property Deposit Bond which guarantees for the builder that the deposit will be paid. The benefit to the buyer is that a large chunk of money doesn’t have to be tied up in a home builder for several years while construction finishes.
CBL also owns Professional Fee Protection, a UK based reinsurance business which insures against Her Majesty’s tax collectors. In the event of a tax investigation, PFP products cover the cost of hiring expert accountants to provide tax advice. There are other niche products including cargo insurance and travel agent insolvency insurance among the CBL stable.
I like these businesses a lot because both customers and their counterparties (e.g. builders) are highly incentivised to avoid making claims. A building collapsing due to structural faults is a disaster for both the builder, who could expect serious litigation, and the buyer, who has had their home or business destroyed. You can’t disincentivise a cyclone, nor can you litigate against it after your house falls down. CBL has no natural disaster exposure.
A very profitable business
The various niches that CBL operates in are very profitable. In the past 5 years, CBL’s claims ratio (the percentage of net premiums paid back to people making claims on their policy) has hovered just below the target ratio of 35%. CBL’s combined ratio, which includes claims, admin expenses and so on, is around 75%-80%, compared to 90% or higher at majors like Insurance Australia Group Ltd (ASX: IAG) and QBE Insurance Group Ltd (ASX: QBE). CBL expects to move its average combined ratio lower over time, so it could potentially become more profitable still.
Additionally, CBL’s profits were impacted nearly 30% in the past year by a weaker NZD/EUR exchange rate. My understanding is that the impact was a ‘paper loss’, i.e., the funds were not actually converted into NZD and remained in Europe in Euros. The investment case does not rely on that benefit – I think CBL is good value without it – but if so, CBL is cheaper than it currently appears.
An expanding network
CBL recently acquired an insurance broker so that it could write business in its own name, rather than just providing reinsurance. Although this appears to have added a lot of staff costs to the company, it also allows greater control over the policies written and a high degree of flexibility. As a European insurer, CBL has already seen benefits from Brexit as European companies look to take their insurance needs outside the UK.
Management also recently announced the acquisition of a well-capitalised but ‘dormant’ (with no policies or employee liabilities outstanding) insurer in the US, which gives them the ability to write business in that market. Expansion into new markets is an important growth avenue for CBL, and there is a chart on that topic further down.
Although CBL carries a small amount of debt (it has $300m net cash), the company currently has a stable A- rating from A.M. Best in both the Financial Strength and Issuer Credit categories. This reflects an ‘Excellent’ ability to meet insurance liabilities and debt obligations respectively. Such a rating is likely to result in greater ease of doing business with insurance partners, as well as more attractive lending terms when the company borrows or issues debt notes.
Management at CBL looks pretty good from my office chair. Most board members own more than 500,000 shares each, with Peter Harris (CEO) and Alistair Hutchison (Deputy Chairman) holding more than 50 million shares apiece – more than 40% of the company combined. Their experience is also both lengthy and diverse, with insurance specialists and a handful of bankers rounding out the board and senior management figures. I’m operating on the assumption that between them, they have the experience to handle just about anything that might come up.
The downside is that external shareholders, for better or worse, won’t have a lot of input into how the company is run.
What are the risks?
CBL is an insurer. The biggest risk to my mind is the long tail on some of its liabilities. If there was evidence that the company had weak risk-management policies or that staff were improperly incentivised to sell big volumes of insurance, that would be a big warning sign. I would not ordinarily expect evidence of this to be easy to find, but a sharp rise in the claims ratio might be the canary in the coal mine.
Similarly, a collapse in the construction market is a risk. This could happen for a variety of reasons. CBL’s global diversification will help, yet profits would still likely take a hit. One argument against the company is that it is cyclical, although given construction activity in western Europe over the past 10 years, I think that it could be closer to the bottom of the cycle than the top. Some types of insurance such as property deposit, construction guarantee, and rental guarantee bonds appear vulnerable to a downturn.
That said, based on CBL’s increasing diversification, I do think this risk will shrink over time:
CBL writes long-tail types of insurance, which means that its financial stability throughout the cycle is important, in case of unexpectedly high claims expenses. The company has recently increased its debt load to make acquisitions, and has a couple more in the pipeline. If the company becomes financially stretched and its credit rating declines, I would strongly consider selling.
Next, expansion into new markets has at times proven destructive for certain major insurers. CBL appears to be going the right way about this with the less-than-bite-sized (US$6 million) US acquisition announced recently. However, I remain cautious and would view big acquisitions and/or acquisitions combined with a weak balance sheet as a warning sign.
Also, I am uncertain about CBL’s competitive position across its diverse businesses. CBL’s main business is in France, and while management reports that they are the dominant player there, unfortunately je ne parle pas français, which is French for “my Google search results for ‘dommages ouvrage’ might as well be in Egyptian hieroglyphs”. In this case I am trusting a combination of management, the strong balance sheet, and the specialist niche to maintain at least above-average profitability.
Further, ‘key man’ risks are very high. Based on limited observation, my opinion is that management are highly capable and founder-led. Any departures would be less than ideal, however I’m also aware that the CEO and Deputy Chairman – who bought the company out in 1996 – have been doing this for over 20 years already. They have been excellent capital allocators and, while I half expect them to retire soon-ish, I’m not excited about the prospect.
CBL shares have very low liquidity. It took me a week to fill my first small order at the $3.50 price I wanted. The exits will be very crowded if there proves to be a problem (real or perceived) with the company’s business.
Finally, CBL has, so far, appeared to have been a very shrewd allocator of capital. Part of the thesis rests on management’s ability to continue to earn great returns from shrewd reinvestment in the business. Should that come to an end, or should funds increasingly be directed into businesses that prove less attractive, it would be catalyst for a re-think of my investment.
The bottom line
CBL looks cheap to me. With a market capitalisation of ~A$730 million (NZ$792 million) it is priced at 26x statutory earnings of NZ$30 million, or 17x underlying earnings of $47 million. There is a good case to be made for using underlying earnings. CBL also has some NZ$330 million -40% – of its market capitalisation in net cash. While some of this is held for regulatory purposes, it’s still hard to argue with a $300 million dollar airbag.
I expect CBL to deliver modest organic growth combined with cautious expansion into new markets. With a strong financial position and capable management, CBL looks very attractive in terms of its price, its growth prospects, and its stability. For all of the above reasons, I believe it is a good opportunity today.
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Motley Fool contributor Sean O'Neill owns shares of CBL Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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