I. Sector Landscape and Outlook

With $3.82 trillion funds managed as of June 2020, Australia is one of the major centres for capital market activity. Insurance and Financial Services sector contributed roughly 9% of GVA (Gross Value Added) in Q3 September 2020 according to the data released by Australian Bureau of Statistics. Insurance and Financial Services sector housed array of activities and services providing a cornerstone for economic development.

Figure 1. Umbrella of Activities

Source: Kalkine Group

Australia is one of the fastest growing economy in Asia. Insurance and Financial Services sector spearheading the growth. The sector posted +3.0% increase in GVA (Gross Value Added) in September 2020 over last year at the time when other sectors are reeling under pressure amidst COVID-19. As charted below, S&P/ASX 200 Diversified Financials Index has outperformed S&P/ASX 200 Index by  7.63% in the last 5 years.

Figure 2. S&P/ ASX 200 Diversified Financials (Industry Group) vs S&P/ASX 200 (*5 year)

With low debt-to-GDP ratio of 23.2% in 2019 compared to emerging and advanced economies as per the data by Australian Trade and Investment Commission, Australia raked sizeable investments from foreign investors. It was ranked 14^th in the world for direct foreign inward investment in 2019 as per Department of Foreign Affairs and Trade.

Insurance and Financial Services sector served as top investment destination by foreign investors. The sector garnered $113.2 billion of investments in 2019, accounting for 11.1% of total FDI received. Insurance and Financial Services sector ranked third next to Manufacturing according to the data.

Source: Department of Foreign Affairs and Trade

Growth Drivers and Key Trends:

• Largest Asset Pool:

Australia has the largest pool of managed funds. The introduction of mandatory retirement income scheme in 1992 saw rapid increase in managed funds. Mature market, sophisticated investor base and efficient regulatory environment are the key drivers. Australians had about $2.914 trillion corpus under superannuation funds (or pension funds) which make-up about 76% of total managed funds as of June 2020 quarter according to the data by Australian Bureau of Statistics. The growing asset base and need for diversification fuelled alternative investment market.

Figure 4. Sizeable Pension Funds Drives the Asset Management Companies in Australia:

Source: Data from Australian Bureau of Statistics, Chart created by Kalkine Group

• Pick-up in Lending:

The onset of pandemic affected household consumption and business investments. Opening-up of the economy started to show improvement in credit growth. The JobsKeeper program and The HomeBuilder Scheme saw increased offtake for housing loans specifically from first-time buyers. Both home loan and construction loan commitments rose in October 2020 as showed by Australian Bureau of Statistics. In a separate release, capital expenditure by businesses to witness an increase in over next three months. With cash rate hitting record low at 0.10%, lending pace to pick-up during the Christmas season.

Figure 5. Recovery in Lending Following Easing of Restrictions:

 Source: Data from Australian Bureau of Statistics, Chart created by Kalkine Group

• Reduction in Cash Rate:

The Reserve Bank of Australia (RBA) adopted accommodative policy stance in-line with other developed economies to revive household consumption and business investments. Since the onset of COVID-19, RBA progressively reduced cash rate from 0.75% in December 2019 to 0.10% currently. In addition, under bond purchase program, RBA purchased about $24 billion of government bonds that brought bond yields down. RBA expects GDP to grow by around 5% in 2021 and 4% in 2022. As mentioned in the monetary policy review, the Board is not expecting to increase the cash rate for atleast 3 years.

Figure 6: Accommodative Policies to Drive Consumption and Investment

Source: RBA

• Fund Raising Activity:

Australia witnessed increased private equity and venture capital funding. Rapidly growing start-ups particularly in fintech sector saw increased participation from venture capital funding. According to Australian Investment Council, the aggregate value of investments in fintech start-ups increased by 190% from 2015 to $867 million in 2019. Increased adaption of smartphones by millennials and growing perennials have created a wave of expansion in payment solutions like The Buy Now Pay Later, etc. Sectors such as healthcare and education are resilient to economic downturns, saw increased investments from private equity funding. Rising population triggered funding for infrastructure development, especially in Sydney, Melbourne, Brisbane, and Perth. Real estate sector was in the lime light for offshore funds specifically in growing student accommodation space.

Figure 7. PE/VC Funding Showing Increased Traction

Source: Data from Australian Bureau of Statistics, Chart created by Kalkine Group

Key Risks and Challenges

The pandemic affected investors across asset classes. Banks and insurance companies took the hit on their balance sheet. The sector was affected by lower yields and change in investment pattern by households.

Figure 8. Key Risks in the Insurance and Financial Services sector:

Sources: Chart Created by Kalkine Group

Gross loans and advances witnessed lowest growth rate in September 2020 since 2010. Significant reduction in personal loan outstanding and weak demand for business loans are the key drivers. Deposit-taking banks witnessed slowdown in asset expansion. Non-performing loans increased due to high unemployment rate and weak business sentiments. Expiry of repayment deferrals and JobsKeeper program may further increase non-performing loans.

As per the data by Australian Prudential Regulatory Authority, insurance companies showed deterioration in performance during the year ended September 2020 mainly due to decline in investment income as the pandemic impacted investment markets. Bushfire and storm events in late December 2019/ early 2020 eroded underwriting profits of general insurers.

Bond purchases by Reserve Bank of Australia impacted yields that eroded investment gains of fund houses. Investors shifted investment pattern during the pandemic period. During the first two weeks between April and early May 2020, Australians withdrew their retirement savings to the extent of $6 billion. This put liquidity pressure on funds and some portion was diverted to cash holdings as well. Although this trend slowly reversed in subsequent period, investors preferred to invest in diversified schemes and equity options.   

Outlook:

Insurance and Financial Services sector to benefit from increase in capex spend by businesses in the next three months as per Australian Bureau of Statistics. Increase in dwelling units’ approval is likely to rebound the construction activity. This may drive housing and construction loans. Further, cash rate may remain stable in the near time as indicated by the Reserve Bank of Australia.

With the increase in ageing population, low interest rates, and expected stability in stock markets, the provision of insurance and wealth management services will be an essential component of customer-focused financial services. As the technological landscape continues to evolve, operations across these companies are expected to become highly streamlined with digital innovations embedded in the process. As a result, shareholders are expected to derive decent returns from such businesses.

After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on ‘Price/Cash Flow’ method. 

1. ASX: PPT (Perpetual Ltd.)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 1.92 Billion)

Perpetual Limited provides asset management, financial advice, and trustee services with operations in Australia, Singapore and the United States.

Valuation

2. ASX: IAG (Insurance Australia Group Ltd.)

(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$ 12.68 Billion)

IAG provides general insurance and personal insurance operating in Australia and New Zealand. 

Valuation

3. ASX: CCP (Credit Corp Group Ltd)

(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$ 1.61 Billion)

Credit Corp Group Ltd. operates as a receivables’ management company, providing debt purchase and debt collection services.

Valuation

4. ASX: NHF (NIB Holdings Ltd.)

NIB Holdings Ltd. provides health insurance services to residents, international visitors, and students in Australia, New Zealand, and internationally.

Valuation

Note: All the recommendations and the calculations are based on the closing price of 10^th December 2020. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).

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