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Clientèle: Below embedded value

The relative appeal of the low-end of the life insurance market.
Irrespective of financial status or position in society, everyone has a desire to reduce risk in their own lives and those of their dependents. A key mechanism for this is life insurance, but the economics of the traditional life insurance business model has historically dictated that little of it ever reached the lower end of the market – the so-called low-LSMs (living standards measure,  which divides the population into 10 groups based on their living standards rather than race or other demographics).
 
Why?

Ignoring the subtleties of the insurance model, it costs the same amount of money to write a small insurance contract as it takes to write a big insurance contract. Thus, from an overhead and route-to-market perspective, the lower-valued, low-LSM life insurance market with small policies is far less attractive to target than the higher-LSM markets with larger policies.

Hence, the larger players have historically built direct and broker-driven models into the higher-LSM markets in South Africa, while the lower-LSMs have been mostly under-penetrated.

Clientèle (JSE: CLI) is one of the few insurance businesses that has focused exclusively on this under-penetrated, low-LSM market. And, driven by economic necessity, it has cultivated a unique route-to-market model that has become quite a robust competitive advantage: a network of Independent Field Advisors (IFA).

IFA is essentially a franchisor. It offers support, education and back-office services to community members all over South Africa who sell Clientèle’s carefully constructed financial products (the main one being life insurance).

Through this arrangement:

1. The franchisor has a route-to-market where costs are largely absorbed by the franchisee

2. The franchisee builds an annuity business that over time generates them wealth, and

3. The end-client gets access to one or more financial products (such as life insurance or a funeral plan) that they may desperately need.

This advantageous network notwithstanding, how does Clientèle compare to its larger peers which focus on the more-profitable higher-end part of the market?

Here is what piqued my interest: Clientèle has a materially higher margin that is better and more profitable than those of the other life insurers.

Figure 1: Clientèle versus JSE-listed life insurance peers

Source: SmallCaps.co.za

Add to this interesting observation the fact that the Clientèle share is trading at an all-time low valuation (figure below).

In fact, the group’s share price has almost never traded below its embedded value (which we believe is quite conservatively constructed; work through its integrated report to get comfortable on its inputs).

Interestingly, if you use Clientèle’s historical average price-to-embedded-value ratio of 1.2x, you arrive at a fair value of 2 335 cents per share (cps) for CLI. This is materially higher than it closed at last week, at 1 755cps.

Figure 2: Clientèle’s share price as a percentage of the group’s embedded value

Source: SmallCaps.co.za

 

While Capitec (JSE: CPI) has launched a life insurance product, we believe this product is more likely to eat into the traditional, higher-end life insurers’ market share rather than Clientèle’s.

In addition, Clientèle’s above-average margins give it far more scope to compete (while remaining profitable) with Capitec than these legacy insurers. Finally, the value of Clientèle’s IFA network should not be discounted. It is a powerful route-to-market platform (indeed, Clientèle has steadily launched more and more products from this powerful platform).

If Clientèle’s products are demanded, and efficiently priced, managed and delivered, and the group is so inherently profitable, why has the market marked its share price down so much recently?

Low-LSMs are particularly vulnerable consumers, thus the group’s underlying base is more cyclical than other insurers. Expect policy lapse rates and withdrawals to be rising; this is no secret, though, and can be traced back to soft consumers in South Africa (a factor more pronounced in retail stocks).

Likewise, domestic small caps on the JSE are particularly fragile (see this more detailed article: Cheapest Equity Sector In The World).

Both risks should reverse as South Africa improves, thus I believe this weakness is transitionary rather than systemic.

Therein lies the upside, and what I suppose is a contrarian call to get into a tightly-held, high-quality asset at the point of peak pessimism. Hence, I have taken full advantage of the risk aversion in this falling market to build what I believe will be an attractive long-term investment in Clientèle in the AlphaWealth Prime Small & Mid Cap (AWSM) Fund.

It does not hurt that Clientèle’s share is paying a 7.1% dividend yield. If nothing else, one can get a greater-than-cash yielding investment with a free option of SA Inc’s recovery!

Keith McLachlan is an equity analyst (small cap specialist). This article was first published on his blog here.

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Interesting but how is the IPA approach different from traditional brokerage businesses which essentially do the same thing?

End of comments.

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