Allianz: A Very Good Deal

by The U.K. Income Investor

I have received a few requests from European readers of The Compound Investor to cover more continental stocks. I shall try to do so on here, starting with German insurance giant Allianz (ALV). Suffice to say, Allianz is a corporate monster. It is one of the largest insurance companies in the world, with an asset base worth around €1,000,000m. No, that’s not a typo: it really does have over a trillion euros’ worth of assets on its balance sheet.

Broadly speaking, we can break this company down into two components. Firstly, the insurance operations I just mentioned above. This covers its Property-Casualty segment, as well as Life/Health, and accounts for most of the firm’s profit. Secondly, its asset management activities. Via its various investment management businesses – including PIMCO – Allianz has around €2,300,000m in assets under management. This accounts for just over a fifth of total company profit.

(Source: Allianz Investor Fact Sheet)

On the surface, it’s easy to see why European income investors like this stock. Its dividend policy is to pay out around half of net income by way of cash distributions, with the per-share amount at least equal to the previous year’s level. Or put another way, it aims to offer stable and increasing dividend income. Moreover, its dividend has regularly yielded in excess of 4.5%. Suffice to say, that compares very favourably to Euro-denominated corporate bond yields. So, you get reliable income with a fat yield to boot. What’s not to like?

COVID-19

Before COVID-19, the answer to that last question was probably very little. At circa €161.50 per share, Allianz stock has roughly doubled in price over the past decade. It has paid out a further €67 or so per share by way of cash dividends in that timeframe. I make that equivalent to average annual returns of circa 11%, not including the effect of reinvesting said dividends along the way.

Speaking of COVID-19, you might expect it to cause a huge amount of problems for the insurance industry. Certain areas just seem obvious. Think travel insurance, to use just one example. I imagine business insurance faces similar problems. That said, certain areas look much more stable. Car insurance seems a good example of that. With many countries in lockdown, car travel has fallen off a cliff. Fewer cars on the road means that accidents and insurance claims should drop as well. For that reason, some firms are even offering refunds to policyholders.

In terms of Allianz specifically, it has a business line in commercial credit insurance. This protects businesses from things like the late payment of invoices, or even outright defaults. If a wave bankruptcies were to take place because of a depression, well, that would hit Allianz for obvious reasons. On the plus side, governments seem ready to help out with unprecedented support. Unsurprisingly, Allianz has withdrawn its previous 2020 guidance which had operating profit in the €12,000m region. We will learn more when the company reports 1Q20 results next week.

Interest rates are the other major problem for insurers. These have been chronically low for some time now, and the  policy response to COVID-19 has simply driven them down even further. Like most insurance companies, Allianz invests the premiums it receives into safe interest bearing assets like bonds. Reinvesting these at lower interest rates and bond yields equates to lower investment income.

Outlook

In spite of the above, I am optimistic here for a couple of reasons. First and foremost, its balance sheet is in good condition. Its SII ratio stood at circa 212% at the end of last year, so it is well capitalised. What the heck does that mean, I hear you say. Well, insurance companies are required by regulators to adhere to certain solvency capital requirements. This is a set at a level so that the insurer can meet its obligations to policyholders over the next twelve months with a 99.5% confidence level.

At Allianz, this figure stood at €39,500m at the end of last year. As for the numerator, its own funds stood at €84,000m at the same time. Dividing the latter by the former gives us our SII ratio of 212%. Now, this figure is subject to pretty wild swings depending on interest rates, equity market movements, and so on. That said, Allianz is a conservatively run business; something which is reflected in its current AA/Aa3 credit rating. It has been around for 130 years, and will still be around when all of this is done.

(Source: Allianz FY19 Investor Presentation)

The second reason I like Allianz stock is, put simply, its valuation. Normalised earnings power is somewhere in the €7,750m area after tax – call it €18.50 on a per-share basis. The current stock price stands at around €161.50, having traded as low as €120 back in March. On that basis, Allianz trades at a current earnings yield of circa 12%. Moreover, it pays roughly half of profit out by way of cash dividends.

Here’s where I get interested. In theory, Allianz could grow that 6% dividend at mid-single digits simply via stock buybacks. Obviously, I’m talking long-term here, way beyond the coronavirus. Nonetheless, it seems nailed on that the stock will pump out over €100 per share in dividend cash over the next decade. That is a very good deal against its current share price and wider bond yields. On that basis, I expect double-digit annual returns here in the long-run.

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