The Rebuilding Of Tower

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This story features TOWER LIMITED, and other companies.
For more info SHARE ANALYSIS: TWR

It's taken a long time for insurance company Tower to recover from the cats of the devastating New Zealand earthquake, but a view is now emerging the market is undervaluing progress made to date.

• Tower was hit hard by Canterbury earthquake
• Recovery now evident
• Guidance levels now seen as achievable
• Tower is considered undervalued versus peers

By Greg Peel

In the decade following the 2010-11 Canterbury earthquakes, New Zealand-based insurance company Tower ((TWR)) faced significant financial stresses with a long tail of claims stretching its capital position and ultimately leading to equity raises in FY18 and FY20, Jarden recalls.

Since then, residual claims have eased and Tower has implemented operational improvements with profit lifting to structurally higher levels.

Alongside top-line growth, management expense efficiencies (digitisation, Fiji back office, product rationalisation) have been the largest drivers of profit growth since FY15, Jarden notes.

Last November, Macquarie suggested Tower was still delivering rare organic growth, but the late-cycle pricing backdrop and rising catastrophe plus expense risk prompted this broker to downgrade its rating to Neutral from Outperform.

Levers were being pulled that are “slightly more risky,” Macquarie warned, with the business guiding to a NZ$45m large event allowance and the broker suspecting this will “land at NZ$55m”.

Tower’s FY25 results met guidance and management was guiding to more than a 7.5% compound annual growth rate (CAGR) to FY28, well ahead of forecasts.

Macquarie stated at the time, “we need to see it to believe it”.

Believing It

By February, Citi was suggesting Tower was entering a phase in which execution, rather than benign weather and rate increases, should increasingly determine its future risk profile.

Having achieved 9.5% gross written premium (GWP) CAGR growth in the last three years, the next leg of the equity story will likely be shaped more by the insurer’s ability to compound market share in home insurance, scale partnerships and reduce its high cost base, Citi suggested.

Tower is targeting for growth in the home insurance market, a segment that is historically highly competitive but also offers higher premium per policy and longer customer tenure.

Citi thinks Tower’s focus on both direct channels and partnerships with affinity channels such as Westpac and Kiwibank could create a plausible pathway to more than 7.5% GWP CAGR growth to FY28, provided it does not sacrifice its underwriting discipline.

With risks of softening interest rates and headwinds from the New Zealand macroeconomic environment, Citi forecasts 5% GWP growth in FY26 before picking up more momentum, including partnerships, in FY27-FY28.

Citi believes the effects from scaling its New Zealand business could help deliver the targeted group improvement in monthly expense ratio (MER) from 31.4% in FY25 to 28-30% by FY28.

At the same time, continued investment in digital and improvements in operational efficiencies should help Tower reduce its MER closer to its peers’ average of around 20%-25%, suggesting there might be some upside risk in time.

While this undoubtedly comes with both execution risks and risk of competitive response from larger incumbents, if achieved, Tower should see more than 7.5% GWP CAGR growth in the medium term, Citi believes.

The investment question is no longer whether Tower can survive adverse years, but whether it can generate returns in average ones.

In Citi’s view, the balance of evidence now points to a business that has the prospect of a more stable earnings profile.

Getting Stronger

In the present day, Jarden believes Tower is a significantly stronger business and, at around 8x Jarden’s forecast near term earnings, this improvement is yet to be reflected in the share price.

Jarden expects Tower’s earnings to continue to be volatile year on year, reflecting the underlying nature of the natural hazards insured.

However, the insurer is considered well positioned to deliver meaningful earnings through the cycle. Jarden notes at the time, the Canterbury earthquake was the fourth-largest insured natural disaster globally, suggesting it was indeed an exceptional event.

Jarden’s review of the large event claims suggests Tower’s P90 (90% confidence) guidance for these claims appears reasonable, with FY23 being the only year in the last twelve in which actual claims exceeded the 8.6% of net earned premium level implied by Tower’s P90 forecasts. 

In the negative column, legacy customer remediation issues continue to be a drag, but Jarden expects Tower’s ongoing investment in systems and processes, and the industry-wide change in sales practices, should see these improve over time.

Jarden estimates these issues have cost more than -NZ$30m since FY22 with further costs expected in FY26.

Jarden assumes -NZ$17m over FY26-FY28 (or -NZ4cps of valuation) and notes this as an outstanding risk.

Achievable

Tower had a poor track record on dividends until FY20 with the drag from the earthquake being the key issue. 

However, the capital position has been restored, and the business has returned some NZ$180m to investors over the last five years.

Given the strong GWP growth expected over the near term, Jarden’s modelling suggests a 50% payout over FY26 and FY27 to support regulatory capital requirements, but that the payout can then step back up to the top half of the policy range of 60%-80% thereafter.

Tower is expecting FY28 GWP to lift by more than 25% in FY26 versus FY25, supported by recently signed partnership agreements (Westpac and Kiwibank).  Jarden assumes Tower reaches its FY28 GWP target and adopts management’s FY26 and FY28 guidance metrics, which appear achievable. 

Noting significantly elevated return on equity over recent years, Jarden’s forecasts factor some long-run reversion as Tower invests to maintain competitiveness.

Jarden assumes a long-run average claims expense, which contrasts with consensus forecasts showing claims near the full P90 allowance.

On the Radar

Macquarie downgraded Tower to Neutral last November, suggesting it needed to see evidence of management’s growth guidance being achieved before believing it. As to whether Macquarie now believes it is unclear as the broker has not returned to Tower in the ensuing five months.

Macquarie set a target price of NZ$1.80.

Citi initiated coverage of Tower in February with a Buy rating, suggesting the insurer’s rebalanced growth mix should help provide it with a multi-year growth runway. On Cit’s estimates, Tower was trading at an 11x PE or a -30% discount to Insurance Australia Group ((IAG)) and Suncorp ((SUN)).

If Tower can demonstrate a more consistent underwriting result and earnings quality, Citi said, it should justify a valuation multiple closer to its peers. Citi’s target is NZ$2.15, or A$1.85, noting Tower is dual listed on both sides of the Tasman sea.

At the end of last month, Jarden was next to initiate coverage, opening with an Overweight rating (one rung below Buy) and an NZ$2.42 target.

Jarden’s spot valuation represents a 10.2x forward PE multiple, up on Tower’s 9.4x average since 2014, with the uplift reflecting a view the business is materially stronger with legacy issues abating.

Jarden is attracted to Tower’s near-term outlook for solid earnings growth, supported by recently agreed partnerships. Risks include large event claims, customer remediation, and a reversion of elevated return on equity.

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