Steadfast in its approach

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The Markets

This week: ASX v Wall Street

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The company was founded in 1991 and has become one of Australia’s largest insurance networks, with over 3,500 brokers across 400 broking firms.

Steadfast has a $5.6bn market capitalisation and is included in the ASX100 largest companies.

Steadfast has developed an enviable reputation as a high-quality growth stock in the Australian market. The pullback in equity markets in the three months ending October 2023 allowed us to add it to clients’ Australian equities’ sub-portfolios.

We continue to be attracted to insurance companies in the financial services universe. Insurance is a beneficiary of rising inflation, and existing companies with strong operating models tend to benefit from higher interest rates.

Steadfast has been growing its business, the extent of its broker network, revenue, margins, and profitability for more than 10 years. It has been assisted in this growth by price rises in insurance, which have continued to outpace inflation. The figure below shows the average premium growth in ‘Commercial Lines’ since 2014.

Steadfast: Premium growth – an underlying source of SDF revenue growth

Steadfast (SDF)– underpinning future growth – a 4 step M&A opportunity

The standout feature of the company and its highly regarded management team has been its track record of accretive acquisitions. “Accretive” refers to the capacity for an acquisition to grow the company’s earnings per share despite the increase in the number of shares outstanding or after the interest costs incurred on the amount of debt raised to purchase it.

The chart below shows the scale of acquisitions the company has made.

Source: Company reports

Since its IPO, company management has identified 4 paths within their M&A toolkit as a means of providing SDF with continued advantage and, consequently growth.

1. Trapped Capital – where Insurance Broker principals wish to partially sell down some of their franchise equity, typically later in their careers, but while maintaining ongoing client relationships.
2. Whole Agency purchases – involving the purchase of separately-branded agencies (currently 29), typically with specialisation in a niche insurance product category. About half the business written by these agencies is placed on behalf of non-Steadfast Network brokers.
3. Technology Assets – An ability to implement a consistent platform to various franchises. Steadfast’s Client Trading Platform has been developed to provide brokers with automated comparative quoting marketplace. INSIGHT is an insurance broking platform which provides brokers with a single view of their clients. Additionally, smaller individual brokers often do not have the budgets and capability to run contemporary tech architecture with API access.
4. Risk Management Tools – the company-wide discipline that Steadfast brings to the growing network can improve existing tool in target businesses.

Domestic agency purchase – a Sure thing

Steadfast announced in mid-November 2023 that it had acquired a 70% equity interest in Queensland-based underwriting agency Sure Insurance for a price, including an upfront cash payment, of $148.8 million. Sure Insurance is a specialist underwriting agency that provides home and contents insurance to homeowners in regional Queensland. The company has a strong track record of growth and profitability.

To fund this transaction and provide scope for further acquisitions over the next 12 months, SDF undertook a capital raising of $280m to provide balance sheet flexibility. First, Samuel is comfortable with this capital raise and participated accordingly, given the outstanding track record of deal execution over the company’s history. Lending weight to this view, the company has made equity raisings to support its growth agenda in 2021 and 2022. In the 12 months after each capital raise, the stock has outperformed the All Ordinaries by more than 20% (on average).

We believe that an entry price for Steadfast at current levels is attractive. The share price trades at a significant discount to our base valuation, an even more considerable if we attribute value to US expansion at a discount to international peers. The chart below shows the relative price-to-earnings ratio of Steadfast compared to global peers. This type of chart can be informative insofar as it removes the movements in a peer-set prices which affect all companies, and isolates the factors specific to the company itself. The chart suggests that Steadfast is trading at a discount to peers.

Steadfast: Historical relative price-to-earnings ratio of Steadfast to international peer set

A US beachhead also established

In October, SDF expanded its network in the US market, acquiring ISU Group (ISU) for US$55m. ISU is a large independent insurance agency network comprising ~220 members and writes ~US$6bn of Gross Written Premium (GWP), operating across ~40 US states. This purchase represents up to 40% expansion to the GWP pool which SDF will manage at a Group level.

ISU Group – US Member map by region

The size of the opportunity that the US represents in any market is vast, and this is no different for Steadfast. As shown in the tables below, the company is expanding from an Australian market which it dominates (32.9% market share) to one in which it is only beginning to make an impression.

Comparative market size in the Intermediated Insurance market

The track record of Australian companies succeeding in the US is limited outside some medical names, Visy Industries and Brambles. The list of failures, on the other hand, is extensive.

For this reason, the market currently attributes little value to Steadfast’s US plans. This is too cautious in our view. Steadfast has many features critical to growing successfully in the US.

1. We believe that SDF’s US market expansion offers scope for Steadfast to expand effectively by offering to unlock equity (‘trapped capital’) for business principals in target firms.
2. Steadfast’s technology solution offers these businesses a common platform to work from, providing an edge as an acquirer over Private Equity firms, who have been the primary acquirers of Insurance Brokerage firms in recent years.
3. Steadfast’s broad range of insurance categories managed will also provide scope to US-domiciled purchases.

We view this network deal as an initial and measured beachhead into a large and scalable market, that can ultimately extend the runway of both organic growth and the broker acquisition pipeline over the long-term.

Investment thesis

Referring to our standard set “Themes and Structural Drivers” that we look to identify good opportunities Steadfast provides the following access to these themes.

• Decarbonisation – Decarbonisation has little direct impact on Steadfast, although the impact of a changing climate on the insurance industry has been substantial. As the world comes to terms with higher levels of storms and other catastrophic events, the cost to insure against the events at the individual business level and as an industry-wide reinsurance level has risen substantially. These rises benefit Steadfast with higher revenue and likely increases the opportunities for industry consolidation that they are beneficiaries of.

• Companies that benefit from inflation – Yes as discussed.
• Technology – One of the main appeals of Steadfast is its technology-led solution that it provides the broker network. This could prove especially valuable in the fragmented US market.
• Strategic assets – No.
• Cheap – Unfortunately, Steadfast is not cheap on standard metrics. It, however, is cheaper than our longstanding valuation of the company and cheaper than international Insurance broking peers.
• Growth – We expect the track record of sales and profit growth Steadfast has achieved will continue to be a critical aspect of the stock.

Summary

As we continue to deploy excess cash in the Equities sub-portfolio, we have looked to opportunities provided by recent market weaknesses. Steadfast provides exposure to an industry we like, and operating model which has strong cash and high margins.

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The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.