All About Wind – For Insurers, Energy Companies And Clothing Retailers

This story features SUNCORP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SUN

By Greg Peel

Last night I watched a video of the movie 2012, in which the ancient Mayan prediction of the end of the world comes true. The story begins in 2009, as a spate of seismic activity alerts scientists to something more alarming going on with regards to solar flaring. It was interesting to watch the movie and recall just how many earthquakes we've had across the globe lately, and on the local front to consider just how many cyclones, flooding rains and short but highly destructive storms we've endured in a short space of time.

If you are an Australian insurance company executive, you're probably now terrified of turning on the nightly news. If you're a global reinsurance company executive, you're probably now lying in the foetal position.

Reinsurance, nevertheless, is now playing an important safety net role for Australian insurance companies. The most recent disasters, in a long list of weather-related disasters in 2010 alone, have been the storm in Perth and the Queensland landfall of Cyclone Ului. There have been so many such disasters this year that investors could be forgiven for believing the likes of Suncorp-Metway ((SUN)) and Insurance Australia Group ((IAG)) must be close to breaking point on claim payouts. But that's where reinsurance comes in.

Without trying to go into the detail of what is a very complex arrangement, Australia's insurance companies are protected by reinsurance policies which kick in past a certain point of provision withdrawal. Insurance companies put aside provisions for extraordinary claims, but once a certain point is passed, aggregate reinsurance protection caps further draw-downs.

While Suncorp has yet to readjust guidance in the wake of these last two events, stockbrokers note aggregate protection will now cap payouts from any subsequent event at $10m up to the end of the financial year. While IAG has moved to downgrade its margin assumptions, it has likely also hit the reinsurance trigger as well, brokers suggest. IAG has some provisions left in the can for FY10 which should be sufficient, but should now have event payouts capped at $15m through to end-December.

Thus while analysts have further reduced earnings forecasts and margin expectations post Perth and Ului, there is not a huge amount of downside left. FNArena's broker database has a Buy/Hold/Sell ratio on Suncorp of 6/4/0 and on IAG of 3/6/1. Of the two, IAG is seen as having the lesser upcoming catalysts for valuation improvement.

It must also be noted that a spate of disasters can be a two-edged sword for insurance companies. Often such events are an excuse to raise premiums, which then means higher margins in the next period.

The winds have been blowing in Australia, and wind farmers can take heart that they should benefit from proposed dramatic changes to federal renewable energy target legislation. The focus on the change is a swing away from small-scale projects as target contributions, such as household solar installation, towards large-scale projects. Last year's supply of renewable energy certificates (REC) included 60% from small-scale projects, notes RBS.

The legislation forces Australian utility companies to produce a certain percentage of their power from renewable sources even though those sources are much more expensive at this stage (and possibly ever) than coal-burning power stations, for example. If a utility is unable to do so from its own sources, it must “buy in” that power. The system works via RECs which are a not unlike a “carbon credit”. If you produce renewable energy you generate RECs and if you can't produce enough to meet your target, you must buy RECs from someone else.

Legislation changes are expected in May and are not expected to meet Opposition resistance. RBS notes the price of an REC has risen 25% since the government announced changes, and the winners are thus those stocks who produce RECs rather than having to buy them. RBS suggests the “key” winners are those stocks leveraged to wind farm development, being AGL Energy ((AGK)), Infigen Energy ((IFN)) and Transfield Services Infrastructure Fund ((TSI)).

Origin Energy ((ORG)) is also planning some wind projects, but in Origin's case valuation is heavily weighted towards the success or otherwise of its Asia-Pacific LNG project.

The potential for further REC price rises is also driven by the situation in NSW, RBS notes. Given the NSW government's on again, off again electricity privatisation plans, NSW retailers are longer term “short” RECs as they sit in limbo waiting for somebody – anybody – to make an intelligent decision.

Of the three stocks suggested above, RBS prefers AGL given its wind farm progress, while Infigen's valuation is currently dependent on a successful US asset sale and TSI's fortunes are linked to an upcoming strategic review.

But if you had to get out into the wind and rain, what's the best protective clothing to wear? Kathmandu clothing, of course.

The growing popularity of outdoor activities among the populace has led GSJB Were to add the recently floated Kathmandu Holdings ((KMD)) ((KMD.NZ)) to its New Zealand Conviction List. Weres' Conviction List includes those stocks to which the analysts have ascribed a Buy rating, but which are the most compelling stories amongst the bunch.

Kathmandu is the largest retailer of outdoor apparel in NZ and Australia with daylight second, notes Weres. The company boasts a strong brand, with a strong business model and growing economies of scale in an improving consumer spending environment. The analysts are expecting a 17% compound return out to 2012 and suggest the stock's current FY11 PE of 12.1x is very attractive.

Kathmandu joins five other stocks on the Weres NZ Conviction List, being Guinness Peat Group ((GPG.NZ)), Mainfreight ((MFT.NZ)), Methven ((MVN.NZ)), Nuplex Industries ((NPX.NZ)) and Pumpkin Patch ((PPL.NZ)).

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