Admiral Group: High Growth And High Yield

In terms of the various financial ratios and other metrics I’m most interested in, the company also looks extremely good:

• 10-year unbroken record of profitable dividends
• 10-year average ROE = 53.6% (FTSE 100 approx. 10%)
• 10-year Growth Rate = 13.3% (FTSE 100 = 1%)
• 10-year Growth Quality (i.e. consistency) = 91.7% (FTSE 100 = 54.2%)
• 5-year average Combined Ratio = 89.6% (market average over 100% according to Admiral)
• Operational debts to 5-year average earnings ratio = zero (I think anything below 4 is reasonable for a cyclical company like Admiral)

The ROE figure is incredibly high. In fact it’s suspiciously high and the reason is that Admiral is a very unusual insurance company. It’s unusual because over the last 10 years most of Admiral’s profits have come not from insurance, but from something which the income statement calls “other” profits.

These “other” profits are made up primarily from “additional products and fees”, which includes breakdown insurance, car hire, personal injury insurance, instalment charges and fees for things like cancelling mid-term or sending out replacement documents. All of those are sold to or charged to its car insurance customers, boosting income per car by something like £70 a year.

On top of that there are profits from Confused.com and other international comparison websites (which Admiral owns) and perhaps in the future there will be profits from the sale of BRIAN the Robot toys as well.

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These “other” profits are an area that Admiral focuses on to a much greater extent than other direct insurance companies.

One way to look at Admiral then is as a lean, low-cost insurer with the primary aim of gathering as many (profitable) insurance customers as possible in order to charge them for “additional products and fees”.

When I insured my car through Admiral a couple of years ago I remember being bombarded by questions asking if I wanted this or that add-on product or service. Now I know why.

But Admiral takes it a step further. 40% of the business it writes is effectively written for another insurance company through a co-insurance agreement. Admiral effectively passes the policy straight to this other company so that none of the premium or claim obligations show up in its accounts.

What’s the point of writing business which is then shuttled immediately off to some other company? So that it can sell that customer breakdown insurance, hire them a car or charge them some administrative fees, all of which stay as a profit for Admiral rather than the coinsurance company.

Another 35% of Admiral’s business is reinsured, which is similar to coinsurance but in this case the figures do show up in the accounts.

So for every policy that Admiral underwrites fully (25% of the total), there are effectively another three policies (75% of the total) that if feeds to other insurers, and three additional customers to whom it can sell additional products and charge additional fees.

The result is massive profits relative to the amount of capital (i.e. equity) that Admiral needs for its own underwriting operations and therefore a massively high return on equity.

Because Admiral only needs a small amount of capital on its balance sheet relative to its earnings, it can pay out most of those earnings as a dividend.

In fact Admiral pays out almost 100% of its earnings as a dividend each year and yet still manages to grow.

This unusual business model certainly appears to have worked over the years. More recently Admiral has started to see profitability coming through in some of its newer international operations, which is where most of its future growth is expected to come from.

If the same model works in other countries anything like as successfully as it has worked in the UK then the future may be very bright indeed for Admiral.

Another unusual feature of Admiral is its dividend policy. First of all it doesn’t have a progressive dividend policy. In its most recent set of results it cut the dividend by 1% even though those results were by no means bad.

Most income investors instinctively see a dividend cut as a sign of weakness, but with Admiral the dividend cut is best explained by a quote from the annual report:

We believe it is for our investors rather than Admiral to determine how they wish to invest funds surplus to the requirements of our business. We, therefore, distribute each year the available surplus over and above what we retain to meet regulatory requirements, the future development of our business and appropriate buffers, in particular, the buffer required during a period of transition between two different capital regimes. We also believe that the year on year progression of our dividend should largely mirror the movement in after tax profits, subject to any abnormal demands on our capital resources.

This is a sentiment that Buffett and Munger would very likely approve of. Capital which cannot be deployed at attractive rates should be returned to shareholders.

The second unusual thing about Admiral’s dividend policy is that it pays a “special” dividend every year. The “normal” dividend is set at 45% of post-tax profits and historically the special dividend has ended up at more or less the same size.

The result of this setup is that many stock market data sources only quote the normal dividend. If you look at some prominent websites (I won’t name them) you’ll see Admiral’s dividend yield quoted as 46.2p, which gives the company a dividend yield of 2.9% with the share price at 1,600p. For a company with market-beating growth over many years a 2.9% dividend sounds about right.

But the reality is that Admiral’s dividend last year, including the special dividend, was 98.4p, which gives the company a much more interesting yield of 6.1%.

Obviously the professional investors who drive the market wouldn’t miss something like that, but it does make me wonder.

Of course I don’t have a crystal ball, and in reality neither I nor anybody else knows what Admiral can or cannot do in the future. But from its past record, and its current price, I think Admiral offers an attractive combination of high profitability and low price.

Disclosure: I have owned shares in Admiral Group since November 2013 and it is also a holding in the UKVI model portfolio.

Original Post

Written By: John Kingham