JohnnyGreig/E+ via Getty Images Swiss Re (OTCPK:SSREY) is a company we had not even considered in the past due to its history of aggressive expansion, excessive leverage, and bad acquisitions. That said, the company appears to be transforming itself, becoming more focused and disciplined, and earnings appear set to recover. Some headwinds are likely to start dissipating, such as high natural disaster costs normalizing, and Covid issues receding. In the first nine months of 2022 the company’s performance was heavily impacted by elevated Property & Casualty Reinsurance loss activity, while Life & Health Reinsurance and Corporate Solutions were well on track to reach their 2022 financial targets. The company has yet to report results for the whole of 2022. The company sounds confident that results will improve, given rising interest rates and their favorable position for upcoming insurance contract renewals amid rising prices and constrained market capacity. Swiss Re will be transitioning to IFRS in 2024, which it believes will bring several benefits, such as greater comparability across the industry, and an acceleration of earnings recognition which better reflects the underlying economics. It expects to report a higher level of shareholders’ equity and higher earnings as compared to US GAAP. Something that got our attention is that the company is setting itself a return on equity target of 14% for 2024, to be achieved by higher Life & Health Reinsurance profits, attractive margins in the Property & Casualty businesses and continued cost discipline. We believe that if the company can meet this target, shares are very likely undervalued at current prices. The company also has a rapidly growing segment called iptiQ which is likely to turn profitable in the next few years. This business is a leading white label digital insurer with significant potential in the B2B2C space. It is experiencing rapid growth, with gross premiums written growing at a +85% CAGR, and it is expected to achieve break-even by 2025. For all of these reasons we believe the company might experience better earnings in the coming years. Deep modelling expertise As one of the largest property & casualty re-insurers in the world, Swiss Re has a lot of underwriting experience and advanced models. What we like is that they continue refining their models to reflect evolving risks like climate change. Since 2019 the company has developed 15 new models and enhanced 12, covering a significant percentage of their exposure. Swiss Re Investor Presentation This is critical, because even though the company has on average earned profits from its natural catastrophe book, there have been years where it experienced significant losses, as can be seen in the slide below. Swiss Re Investor Presentation Rising interest rates tailwind While most companies are expected to see their earnings negatively impacted because of rising interest rates, insurers are one of the few exceptions where this is usually a tailwind. The company is now able to invest its ‘float’ at higher rates of return. As can be seen below the company’s investment portfolio is starting to generate more income, in particular the fixed-income part of the portfolio. Swiss Re Investor Presentation This should also help achieve the return on equity target of 14% for 2024, which is significantly higher than the 5.7% it achieved in 2021. The company expects its ROE to be even higher under IFRS. The slide below does the walk from the 2021 ROE to the expected 2024 ROE. One of the main drivers is the Covid normalization. Swiss Re Investor Presentation Financials The company is not a fast grower, even if it has some promising segments like iptiQ scaling at a rapid pace. The last few years Swiss Re has grown revenue at a ~5% average. It has massive revenue of ~$45 billion, but its earnings have been disappointing as can be seen in the graph below. Data by YCharts Balance Sheet Swiss Re has a strong balance sheet with an AA- credit rating from S&P, and a ~223% Swiss Solvency Test ratio, which means the company has a significant amount of extra capital over and above the claim amounts and losses it is likely to incur. Swiss Re Investor Presentation Swiss Re has the following to say about its SST, which as we understand has a lot of similarities with Solvency II: The SST ratio is a function of available and required capital based on an economic valuation of assets and liabilities with an integrated forward-looking assessment of underwriting, financial market and credit risk and, therefore, our SST ratio could fluctuate from reporting date to reporting date, and such fluctuations could be significant. ESG Swiss Re is recognized as a leader in ESG practices. It co-founded the net-zero insurance alliance, and is considered a market leader for offshore wind risks. Swiss Re is aiming to reach net-zero emissions from its own operations by 2030 and from investment and underwriting portfolios by 2050. It also has some ESG guidelines, such as exclusion from re/insurance to the 10% most carbon-intensive oil & gas producers. Swiss Re Investor Presentation Valuation Given the volatility of its earnings, which have been depressed in recent years due to numerous headwinds including Covid and natural catastrophes, it is difficult to value the shares with high accuracy. Right now shares have a ~6.7% dividend yield, which the company hopes to grow or at least maintain in the future. Dividend growth in dollars has averaged ~6% in the last few years, and ~4% in Swiss Franc. The company is planning to transition to a USD dividend from 2023 onwards. Swiss Re Investor Presentation We estimate shares are trading at less than 13x of what earnings could be if the company meets its 15%+ ROE target. Of course, there is no guarantee the company will meet this target. The current P/E ratio is much higher, at ~50x, but earnings are expected to improve very significantly. Data by YCharts In this case a better valuation metric might be the price/sales ratio, which is currently close to the ten year average. This reaffirms our belief that shares are relatively fairly valued at the moment. Data by YCharts Risks As an insurance company, Swiss Re is exposed to significant risks, from natural catastrophes to pandemics, and others. These are out of the company’s control, and can mean the company reports horrible losses in any given year. Swiss Re is also exposed to risks from its investment portfolio, which includes debt and equities among other classes of investments. All of these risks are mitigated by the company’s strong capital position. Conclusion Swiss Re is in the middle of a transformation, becoming more focused and disciplined, and has set itself an ambitious target of reaching a 14% ROE in 2024. The company has an attractive dividend yield and a reasonable valuation, but we would like to see more progress towards sustainable earnings to rate it a ‘Buy’. We plan to continue following the company in the future, and for the time being we rate it a ‘Hold’. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
