Raging wildfires; floods; a container ship crashing into a bridge; a flawed software update causing planes and operations to be cancelled worldwide; hurricanes. You don’t have to look far to find examples of costly catastrophes and grasp the scale of the destruction they leave behind.
As the rest of us look on in horror, reinsurers step into the action, picking up the pieces and assessing their liability to such events. To prevent financial wipeouts, they manage risk through data, disciplined underwriting, and diversification. Lancashire, one of London’s big reinsurers, is expanding its US property book for example, while rival Beazley has stepped into cyber security. The latter had exposure to the CrowdStrike software fallout, but comfortably absorbed the hit.
Market cycles are another control mechanism. In years when there are no major disasters, groups build up reserves. These lulls often follow a period of heavy claims, which in turn lead to a hardening of premiums helped by some providers backing out of the market.
If you think it sounds risky, it is and climate change is increasing the risks. But the rewards can be good. Reinsurers are reporting record levels of profit now and buying shares in these groups is the safest way for investors to gain exposure to this specialist market.
But the risk pales in comparison to that taken on by individuals who signed up as underwriters known as Lloyd’s Names in the 1990s — back then, thousands lost money as colossal bills for a mountain of asbestos claims and an oil rig disaster landed through their letterboxes.
BUY: Lancashire Holdings (LRE)
Bermuda-based reinsurer Lancashire Holdings has ridden the tide of higher rates and stronger demand to deliver another set of record results, writes Julian Hofmann.
The company generated profit growth of 26 per cent to $200mn (£157mn), with a combined ratio of 82 per cent, which matched the performance of the best in the sector. The only downside, per se, was that Lancashire hit consensus forecasts and shareholders locked in profits on the back of the results.
Lancashire was fortunate to avoid the worst of what was an active claims period for the rest of the reinsurance industry, with events such as the Baltimore bridge disaster not having a material impact on its loss rates. These were $45mn in total, with the Baltimore bridge being the most significant; this was a slightly better result than the $49.5mn loss in the first half of 2023.
Meanwhile, the total impact of discounting for the half was a net benefit of $40mn, compared with a net benefit of $15.8mn in 2023. Higher yields throughout the half showed up in the investment returns for the company’s portfolios; these were 2.3 per cent with a return of $75.2mn, compared with $63.2mn last time.
Management said the company was on track to deliver a combined ratio in the mid-80 per cent range, with a return on equity of around 20 per cent.
Broker Peel Hunt values Lancashire at a slight discount to its peer group of 1.4 times tangible net assets. That translates to a forward price/earnings ratio of 7.4 for 2025. In our view, that still looks good value with more capital generation to come.
HOLD: Balfour Beatty (BBY)
Shareholders are unlikely to reach for the smelling salts when faced with the construction group’s latest half-year figures, writes Mark Robinson.
Despite a mixed showing, Balfour Beatty remains on track for earnings growth in 2024. Overall, it’s not difficult to appreciate the predictability afforded to investors from the types of long-dated infrastructure projects that the group has on its books.
Slow and steady may well win the race, but there are always hurdles along the way. Lower volumes at the Hinkley Point C nuclear project resulted in a 4 per cent revenue decline at the UK construction segment to £1.4bn, and the order book remains flat on the year-end. But improved project delivery helped to boost related underlying profits to £34mn against £30mn at the 2023 half year. Margins are inherently tight given the business model, so the 30 basis point increase in the segmental profit margin to 2.3 per cent is doubly significant.
Orders also underwhelmed within the US construction unit. Project delays here contributed to a 14 per cent reduction in underlying profits to £18mn on a 10-basis point reduction in the related margin to 1.1 per cent. Full-year profitability in this corner of the business is now expected to be flat on the prior year.
Overall revenue growth was supported by an improved showing at the support services division, which remains on track to achieve the top end of its 6-8 per cent targeted margin range. The Hong Kong-based 50:50 Gammon joint venture with Jardine Matheson continues to perform creditably, although it experienced margin pressure through the period. Balfour notes that the market outlook in Hong Kong remains highly favourable with government commitments to expand the railway and major road networks in place.
The group recorded a net working capital outflow of £76mn, yet operating cash flows were ahead of profit from operations — always a reassuring sign.
Panmure Liberum forecasts earnings per share of 39.4p, rising to 43p in 2025.
The government has signalled it will reform the planning system and bring in private investment to boost infrastructure development, but the parlous state of UK government finances stands as a potential impediment on this score.
Balfour continues to expect improved underlying profitability from its earnings-based businesses for the full year, although infrastructure investments are expected to register “a small loss from operations”, prior to disposals. On balance, we remain circumspect given the mixed interim showing.
HOLD: Marshalls (MSLH)
Judging by Marshalls’ half-year results, the trading period to June 30 might best be described as a “holding operation”, writes Mark Robinson.
The manufacturer of sustainable building products still faces the dual challenge of a fall-away in new housing starts and the slump in housing repair, maintenance and improvement that followed on from the pandemic-linked surge in activity.
At that point, household demand for patio and paving slabs was holding up and the group’s order book provided good visibility on the revenue front. Fast forward three years, and the outlook is no longer quite so assured.
The group has managed to reduce pre-IFRS 16 net debt by £28.8mn through tighter working capital controls and surplus land disposals, while annualised operating cash flow conversion came in at 111 per cent of adjusted cash profits. Further efficiencies are being brought to bear through the implementation of self-help measures within the landscape products unit. But for all management’s efforts, adjusted operating profit fell by around a fifth to £34mn on a 70 basis point reduction in the underlying margin to 11.1 per cent.
Marshalls is still swimming against the tide, though it is drawing some encouragement from the new government’s commitment to increase housebuilding starts in the UK. The share price has recovered marginally following a positive technical signal at the end of January and there was a decent showing from the roofing products segment. But with the shares trading at 21 times consensus earnings there is little obvious value on offer even assuming the shares have already bottomed out.
