Cover-More: Not A Risk After All

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-Unique structure in travel insurance
-CLSA retracts criticism
-Improved medium term outlook
-Asian expansion key to strategy
 

By Eva Brocklehurst

Broker CLSA is apologetic. Cover-More ((CVO)), the travel insurance arranger, was the subject of a withering analysis a few months ago but now CLSA accepts the company has some unique features which make it resilient and able to extract more value from its offering, compared with others in the sector. Hence, prospects in the short term are better than the broker envisaged.

CLSA had previously observed that arrangers of insurance such as Cover-More were being squeezed out given distributors – such as travel agents – were contracting directly with insurers. As barriers to entry are low, given the low levels of capital required and high profits, the broker considered the life cycle of an arranger was around 10 years before the structure was in disarray and the arrangements dissolved. Cover-More has an advantage which stands it in good stead in this regard.

Essentially, CLSA now understands that Cover-More has a relationship with the insurer such that it effectively rents the balance sheet of the insurer, controlling all elements in the process of contracting with distributors. Hence, on this basis, prospects are better. Cover-More is able to control pricing of its product and thereby change the dynamics in travel insurance. Claims are controlled and minimised by means of the company's medical assistance capability. As Cover-More can price its own risk it can respond to changes in the travel environment much more quickly than others. The structure removes a stress point in the arranger/insurer relationship – the expense impost on the insurer in the Cover-More structure is minimal, as the insurer provides little else except the capital. Expense management falls within the control of Cover-More.

Another advantage pressed home to CLSA is that Cover-More ties in distributors. Many other arrangers suffer from the fact their distribution agents are lured way by a promise of higher commissions. Cover-More has a joint venture structure with distributors and on average pays marginally less commission. Cover-More's partnering model means it can pick up new distribution partners from other schemes, offering upside to distributors in the form of a more flexible and profitable model. This enhanced return, by means of data mining that occurs only because of Cover-More's ownership of risk pricing, should over time provide increased sales.

After reviewing its model, incorporating increased gross written premium growth, lower gross margin erosion and a slightly increased share of premium, CLSA has upgraded its rating to Outperform from Sell and the target rises to $2.25 from $1.88.

Cover-More's structure, where it rents insurer capital, also guards against bad behavior by insurance carriers. CLSA observes, that in the worst case scenario, Cover-More could convert to becoming a risk carrier and, from an investor point of view, this could be the most important driver of value for the stock.

So where does the broker envisage the biggest risk? The Australian dollar. A devaluation of the Australian dollar leads to less overseas travel. However, CLSA thinks this effect will be delayed as airlines manage their capacity by dropping ticket prices and the impact on Cover-More will be minimal as insurance prices will not drop. Therefore no difference is assumed in take-up rates. The broker retains a previously held view that, from an Australian perspective, the company's unique structure is about diminishing returns. This, ultimately, puts a lot of pressure on the overseas strategy. This is where Bell Potter also envisages upside potential. Cover-More is developing core travel insurance capabilities in India, China and Malaysia where the market is less developed.

Bell Potter believes Cover-More is a growth stock and has initiated coverage of the company with a Buy rating and $2.30 target. The highlight is the strong international theme that has dominated Australia's holiday landscape over the past 10 years. This theme is driven by low airfares, favourable currency rates and increasing capacity from low-cost airlines.

Bell Potter also notes the company has broadened its distribution with the intermediary, e-commerce and direct segments expected to contribute around 25% of rolling 12-month earnings from June 2014, compared with 11% at June 2011. This increased contribution reflects the distribution contracts signed with a series of third parties such as Medibank, Australia Post, Malaysian Airlines and Air New Zealand ((AIZ)) as well as some Australian automobile clubs. Growth has been assisted by the development of the Impulse e-commerce platform to enable partners to maximise travel insurance sales to clients.

See CLSA Warns About Cover-More's Future on March 6 2014.
 

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