Cover-More Juggles Growth And Margins

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-FY16 sales start strongly
-New product, JV in late FY16
-Market share vs margin?
 

By Eva Brocklehurst

On the surface, travel insurance provider Cover-More ((CVO)) continues to deliver premium growth well ahead of the market but brokers observe the latest trading update signals margins are under pressure from cost inflation as the Australian dollar continues to weaken.

Macquarie lowers near-term margin assumptions but considers the squeeze to be largely a timing issue. Margins are expected to improve as re-pricing and portfolio initiatives take hold. The broker notes FY16 sales are expected to continue at similar rates to the first quarter, where Australian sales were up 10.2% compared with the 6.3% growth achieved in the second half of FY15. This reflects both market share gains and re-pricing initiatives.

Revenue growth in India and the UK is also robust, Macquarie maintains, and the company continues to examine acquisition opportunities in the latter market. First quarter revenue growth in India is up over 60%, driven by new agreements, while the company remains well placed to benefit from a growing Asian middle class, brokers suggest.

Of note, a letter of intent has been signed with a US-based partner with the company on track to instigate a joint venture in that market in the fourth quarter of  FY16. A global direct product will also be launched at that time with profit expected to contribute in FY17. Flat conditions are expected to prevail in New Zealand, given the change in the booking pathway from Air New Zealand ((AIZ)), and sales are expected to be softer in Malaysia as Malaysia Airlines, a key customer, recovers.

Medical assistance revenues are also lower than the prior comparable quarter, because of the loss of a key employee assistance contract which had been previously flagged.

Acknowledging selective re-pricing that is taking place UBS believes Cover-More needs to find the right balance of margin recovery while maintaining its market share. Management expects the current run rate in premiums to remain in place for the remainder of FY16, but this is below the broker's prior expectations of growth of 14.5% and drives downgrades to its earnings estimates of 5-6% over FY16-18.

UBS believes the company's key competitive advantages still lie with its specialty focus, scalable platform and capital-light business model. Morgan Stanley too, yet to comment on the AGM update, believes innovation and scalability are what will drive earnings for Cover-More in the months ahead, rather than cyclical factors.

UBS also expects margins will edge higher from here but the emphasis is on "edging" higher rather than bouncing back. Downgrades may likely weigh on near-term market sentiment but the broker observes the stock is down 15% since late August and the valuation is looking more compelling. Hence, UBS  upgrades to Buy from Neutral.

FNArena's database has three Buy ratings for Cover-More. The consensus target is $2.59, suggesting 27% upside to the last share price. The dividend yield on FY16 and FY17 forecasts is 4.3% and 5.3% respectively.
 

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