Priced at 6x last year's annual earnings, surely Genworth Mortgage Insurance Australia (ASX:GMA) shares are a buying opportunity?
The company's share price has fallen 18% over the past year, and 35% over the past five years. Profits have taken a huge hit and the company has also had to change the speed at which it recognises revenue, reflecting the fact that losses are occurring later in policy lives.
Genworth is currently priced at approximately 6x last year's earnings, which on the face of it is very cheap. Other insurers of similar size are priced at 15x or more. However, Genworth's revenues and profits have fallen through the floor in recent years as banks have in-sourced their Lenders Mortgage Insurance (LMI). The recent action by regulators to cap the amount of high loan to valuation ratio (LVR) loans is also expected to reduce demand for LMI.
These pressures appear unlikely to reverse in the near term, and I would not expect Genworth to deliver growing earnings. I feel that one strong possibility is that, after a housing market crash, Australian banks will again look to outsource their LMI (and their risk) to somebody else, which could lead to a major increase to income for Genworth in time.
The only problem with that scenario is that in order to get there, we need to have a housing crash first – and Genworth needs to survive it if/when it does happen. The company has only $1 billion in capital which seems rather small when you consider how many properties it's insuring.
On paper, Genworth is adequately capitalised with a capital adequacy ratio of 1.93x its minimum requirements. However, I am highly sceptical about the expected 'worst case scenarios' that the banks and insurers use in their models. Australia hasn't had a recession in 20-something years and history is full of insurers that were caught out when those scenarios did occur.
Genworth has a vested interest in its survival – no company is going to stand up and say "Yeah, we might go bankrupt in a really severe downturn."
I like Genworth, but I'm also wary of it and I think the downside from here is still potentially quite ugly. However, I also think that once losses on loans become a thing again (big banks are currently taking virtually zero losses on their loans) there will be increasing demand for Genworth's services.
There is also an interesting contrarian case to be made. With so many smart investors assuming that the property market is going to blow up, and pricing Genworth as if it's going out of business, what happens if the market doesn't blow up and we get a gentle deflation, or no change? I think in that circumstance Genworth's future might look a little rosier and it could re-rate to a higher multiple of earnings.
So does that mean Genworth is a buy? I honestly don't know – I'm staying on the sideline for now.
I think it's the ultimate contrarian investment idea though.
