Small Caps | Mar 23 2015
-Cash flow under appreciated?
-Accelerating in China, India
-UBS suggests buy on weakness
By Eva Brocklehurst
Cover-More ((CVO)) is a domestic leader in travel insurance with a differentiated, specialist offering which stands it in good stead, given both structural changes in the population and potential in the global market.
Morgan Stanley considers the company's ability to generate cash flow is under appreciated. Product innovation and global expansion offer upside to the base case and the broker initiates coverage with an Overweight rating and $2.64 target. Capital requirements are light as Cover-More designs its own products while underwriting risk is borne by large reinsurance partners.
Travel insurance a niche business. Morgan Stanley describes it as a small prize with a high cost to serve, unexciting to general insurers in terms of overall profitability. Cover-More stands apart in the sector with claims handling expertise and alignments with partners via profit share rather than commissions. Cover-More also benefits from an Australian middle class with a growing appetite for international travel. Scalable technology should also enable the company to take market share globally, in the broker's view.
Morgan Stanley's bull case involves a bounce in Australian outbound travel together with strong traction in India and China. New distribution agreements should accelerate growth in the latter two markets towards 20%, the broker contends. Moreover, there is an attractive opportunity to scale up in the US and UK which should drive further re-rating. All up, Morgan Stanley expects Cover-More to deliver consistent double digit earnings growth and improving returns for the next 10 or more years.
First half results impressed Macquarie and UBS. Recent falls in the Australian dollar will likely produce a more subdued second half, dampening outbound travel demand and putting pressure on margins. Such is the stock's sensitivity to FX, but UBS considers this a short term risk. The broker believes further weakness in the share price would present attractive entry opportunities.
UBS believes the company has indirectly moved away from its guidance range set in December of $53.8-56.9m for FY15 earnings because of difficulties in forecasting the impact of FX re-pricing and a reluctance to risk long-term channel preferences with higher prices. UBS expects the second half will relatively flat, given the company suggested Australian outbound leisure volume growth was subdued. That said, the broker acknowledges demand elasticity in reaction to price could be higher than usual in the current environment.
Macquarie also observes commentary is more cautious after a very strong first half, a reflection of tougher conditions for the Australian business. Claims costs have increased because of the the lower Australian dollar and this may impact on near-term margins and require policy re-pricing. Still, Macquarie cautions against capitalising into perpetuity any near-term slowdown and margin pressure emanating from the rapid depreciation of the Australian dollar.
There are three Buy ratings for Cover-More on FNArena's database. The consensus target is $2.40, which suggests 16.9% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 4.3% and 5.3% respectively.
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