Swiss Re Offers A Good Combination Of Income And Value (OTCMKTS:SSREF)

Swiss Re (OTCPK:SSREF) is currently offering a dividend yield above 6% and is trading at only 9x forward earnings, making it attractive for income investors.

As I’ve covered in a previous article, Swiss Re is an interesting income investment due to its high-dividend yield that is supported by the company’s strong fundamentals and capitalization. Since then, its share price is up by close to 38%, beating the market by a wide margin during this period.

As Swiss Re has reported some weeks ago its annual results related to 2022, in this article I update its investment case to see if it remains an appealing income play or not, after its strong recent share price run.

Earnings Analysis

Swiss Re reported a mixed performance in 2022, given that its premiums increased due to better pricing in the industry, but on the other hand its results were affected by several negative effects, including higher inflation, Covid-19 claims, losses related to natural catastrophes above expectations, and weaker capital markets.

Its net premiums written increased by 0.9% YoY to $43.1 billion, being negatively impacted by currency moves. Excluding the effect of foreign exchanges, its premiums increased by 5.3% YoY, as pricing improved in the second half of the year across the reinsurance industry.

However, despite higher premiums in the year, Swiss Re’s net income dropped to only $472 million in 2022, compared to $1.4 billion in the previous year. Its return on equity ratio (ROE), a key measure of profitability within the insurance industry, was 2.6% in 2022 (vs. 5.7% in 2021).

This level of profitability is not particularly impressive and this relatively weak performance is largely explained by external factors that pressured the company’s profitability. Indeed, significant headwinds from higher inflation and other one-off effects led to a negative impact of about $2.8 billion in its net income, including about $1.1 billion in provisions to address the risk of higher claims due to inflation across its Property & Casualty (P&C) segment, of which some are expected to ‘normalize’ in 2023.

Showing that a great part of these effects were temporary and have not impacted Swiss Re’s structural profitability, its guidance is to generate a net profit above $3 billion in 2023, which would be the highest annual profit since 2016.

This is supported by the end of the pandemic and more normal catastrophe losses expected this year, plus higher returns from investments. Additionally, January renewals were positive for the company, given that Swiss Re was able to capitalize on attractive market conditions and increase pricing in the P&C business.

Regarding its capitalization, Swiss Re had a strong position at the end of 2022, given that its Swiss Solvency Test (SST) ratio was higher than 280%, well above its internal target range of 200-250%. This strong excess capital position is a key support for the company’s dividend policy, enabling it to deliver a sustainable dividend over the long term.

Indeed, related to 2022 earnings, Swiss Re decided to distribute an annual dividend of $6.40 per share, which is flat compared to the previous year in USD. Investors should note that Swiss Re changed its dividend currency from CHF to USD related to 2022 earnings, thus its previous dividend of CHF 5.90 per share is unchanged when converted to USD, considering the current exchange rate.

This means that at its current share price, Swiss Re offers a dividend yield of more than 6%, which is quite attractive to income oriented investors, even though it has decreased from 8%+ back in October when I previously covered it, due to a much higher share price.

However, investors should note that due to a weak financial performance during the last year, its dividend is not covered by earnings, considering that its EPS was only $1.60 in 2022. This is obviously not sustainable over the long term, with its current dividend being financed mainly from the company’s excess capital position.

While the company has a clear dividend commitment to provide a regular income stream, despite its earnings volatility, its sustainability based on recent earnings is not great. On the other hand, if the company is able to return to a more normal level of profitability, its earnings power is much higher than achieved over the past few years, and more than enough to cover its annual dividend.

Indeed, according to analysts’ estimates, Swiss Re is expected to achieve earnings above $11 per share in 2023, and that grows to about $13.50 per share by 2026. These improved earnings plus the company’s strong capital position would provide a strong backdrop for a sustainable dividend in the coming years, if there aren’t any unexpected hits to its bottom line during this period.

These expectations are in good part justified by improving operating trends, considering that in January renewals Swiss Re was able to increase both pricing and volumes in the P&C reinsurance segment, with a positive economic impact of about $800 million. As the company’s reserve position was strengthened last year, it’s not expected to report higher claims losses than usual in 2023, thus its $3 billion net profit guidance seems achievable and a strong support for a higher dividend next year.

Current market expectations are for Swiss Re to increase its dividend by about 6% YoY to $6.80 per share related to 2023 earnings, showing that Swiss Re’s dividend growth prospects are good. Over the medium term, Swiss Re has maintained its target of achieving an ROE of 14% by 2024 and annual growth in economic worth per share of about 10%, which seems to be achievable from a combination of lower claims costs, higher pricing in the P&C segment, and overall strong cost control.

Conclusion

While its recent results can be considered relatively weak, this is justified by cyclical factors rather than structural issues, a backdrop that is expected to change in the near future. Swiss Re has a strong position in the reinsurance industry, being a key factor for the company to achieve better pricing in recent reinsurance renewals, which represents a strong support for higher earnings in 2023.

This will also improve its dividend sustainability, with its high-dividend yield being key for its investment case. While its shares have had a great run in recent months, Swiss Re is currently trading at only 9x forward earnings, at a discount to its historical average over the past five years of about 10.7x. Therefore, Swiss Re remains an interesting income investment within the reinsurance industry, due to an attractive combination of income and value.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.