Munich Re: My Reinvestments Are Better, And The Company Remains Expensive (OTCMKTS:MURGY)

Dear readers/followers,

As I made abundantly clear in my last article on Munich RE (OTCPK:MURGY) I’ve made a very hefty profit with my investment in Munich RE that I have covered over the course of over a year now. Some readers have commented, or also sent private messages, that I might have sold my stake too early given the return that we’ve been seeing and the trajectory that Munich RE seems to have been able to do.

This is certainly an opinion – and one with a bit of merit, depending on your target RoR. The thing with my own rotation though is that invested my Munich RE stake in a mix of 5 undervalued businesses, 4 of which have significantly outperformed in their own right. This means that my end capital and dividends from this new investment are actually substantially better than what can be, or could be garnered from Munich RE.

Here is the RoR since I wrote on the company last, an article which by the way you can find here.

As you can see, it hasn’t beaten the market, though it has been a good ROR, considering where much of the market has gone in the meantime.

Let’s look at the recent results, an outlook for 2024E, and what we expect from this company going forward in terms of likely upside.

Munich Re – Plenty of quality, not a great valuation

Insurance and reinsurance companies typically trade at a significant discount. Overall, I’m very hesitant to put many of them above a 10-11x P/E because of the risks that investments in this sector entail. Munich Re might be one of the few exceptions, but at this time, even the upper echelon sort of valuations for this company is not where I would necessarily put my money unless you’re interested solely in yield and safety from this sort of insurance play.

We’re in a market where an investment into a CD or a savings account can yield over 3.6% easily. Munich RE, as of this time, yields 2.83%, so we’d need a significant upside from capital appreciation to consider this to be valid. To this, we also need to consider that Munich in fact has risk – and that this risk is not as small as the AA credit would necessarily imply.

Yes, this company has really carved out a competitive position in a number of lines across the business sector. Munich RE is without a doubt one of the most qualitative businesses in this sector on earth. No doubt about that. Still, valuation doesn’t necessarily show the most flattering picture here, despite the company being the largest in the world.

As a reminder, I used to have a YoC of over 4.1% on this business before I sold my stake. Foundationally speaking, this is one of the higher-moat reinsurance businesses around, and it’s also the largest on earth.

Its focus has been to play on its global specialty insurance and its cyber lines, and the P&C insurance premiums for the re segment are growing faster than traditional reinsurance, which is part of what’s driving earnings here. The company has been expanding its inspection-based insurance model, and combining this with the company’s experiences and specializations, we have a significant upside here.

As I’ve mentioned in my other articles, I’m not all that positive about the inclusion of a standard insurance division – even if that division has been able to generate some very solid results. I think it’s somewhat short-sighted and part of the “quarterly game” in order to give the appearance (and also in part reality) of higher and more attractive earnings. I still maintain that Munich Re would do better focusing on this expertise, meaning reinsurance. The personal insurance lines dilute the sales mix, and the company’s ability to actually position itself on the market because it has to consider how its personal lines business matches with this.

Nonetheless, here are the 2025E Ambitions.

If the DPS grows only around that 5% minimum level, then the yield will remain to close to 3% or below, which given many of the high-yield high quality attractive alternatives comes with a meager upside.

The company remains superbly capitalized with a Solvency II ratio of now at over 240%, with a forward potential between 248 to 271% depending on interest rates, equity markets, and other spreads. Part of the company’s target for the new segment was earnings diversification to manage a better payout and DPS. Also, some do consider this more mixed earnings profile to be more attractive for the company long term.

Overall, 2023E results and going for the 2025E targets, are expected to be very solid despite an unclear interest rate environment and a prevailing sort of inflation. The mix of Core P&C Reinsurance, Global Speciality with its solid underwriting appeal, and Core L&H reinsurance makes Munich Re a leader. The addition of ERGO is so-so in my view, but it has increased the company’s earnings for the time being, even with the more muddled company focus.

Overall current renewal rates are up, and the focus, as before, is not on volume but on earnings quality – as it should be. My focus going forward would be on the appeal of the Global Speciality insurance segment, which while not completely unique, is a market leader providing very solid underwriting and earnings results.

A combined ratio in the low 90s isn’t great if you compare it to some insurance operations like Sampo (OTCPK:SAXPF), but on the global scale, it’s very good, especially considering the size of Munich RE. This is in addition of course to the impressive company premium growth.

The fact is though, that all segments are expected to deliver very solid 2023E results when the company reports the full year. The company’s investment portfolio yield is naturally also seeing increases, with fixed-income investments up to close to 3%, from a trough of almost 2% back in 2021. The reinvestment yield, meanwhile, is up above 4%.

And the fact is that, as of right now, on a total return basis, this company is a clear outperformer on a global market. So while I believe that I made the right choice by rotating Munich RE when I had the chance to invest in very solid businesses at competitive prices, I would understand if some held onto their shares, and they have done well since.

It also goes to show you that when this sort of company is in fact cheap, you buy – or at the very least consider what the company could offer you.

Let’s look at risk/reward profiles for the company.

Risks to Munich RE

The risks to Munich RE are relatively limited in nature, and relevant mostly to underperformance due to a limit of a 11-12x P/E, which I consider to be the highest fair value to estimate for a company like this over the long term. Still, a few things worth mentioning for Munich Re that should and might give you pause.

Something to look at is the company’s primary insurance operations, which can be considered a relatively capital-intensive sort of business (as all mainline insurance operations are), and is also exposed to a different risk profile than the company’s reinsurance operations. Over time, this has actually worked to reduce the company’s returns, even if the current trend seems to be an upswing. I would not consider this a de-risk, but a risk-increasing sort of thing to hold.

Also, while Munich RE has size leadership, the company shows no scale or market leader advantage from an expense or claims perspective, whereas instead Hannover Rueck as a peer has superior results in some cases.

There’s also a disadvantage or risk mentioned by some analysts for the company – and that is the fact that Munich Re has adopted a more “partnering” approach rather than trying to develop their own things and businesses. While this is potentially positive – for sure – it also dilutes or at least lessens the RoR that the company could get if they were to develop their own operations and advantages.

All of this leads us to the current valuation, which I do not view as great – but I will increase my PT based on the recent results and forecast to account for the increases in FV.

Valuation for Munich RE

My PT in my last article on the company went clearly above €300/share, and I’m changing my PT here to close to what was implied in my previous modeling, now to €340/share. This means that the company could yield around 3% with an upside of about 15% conservatively, and I would technically consider the company a valuable “BUY” there.

But at this time, Munich RE trades at over €400/share and a normalized P/E of almost 12-13x, depending on where you expect earnings to go. Typically, I would not allow the company to go all that far above 10.5-11x P/E. Forecasting Munich RE at around 11.6x P/E here gives us only 11.6% annualized, which works as an explanation with my 15% minimum as to why I am not that interested in investing in Munich RE at this time.

To reach that 15% annualized here, you need to give the company a considerable degree of premiumization for a reinsurance company that even with the company’s double-A rating, I do not want to engage in at this time.

There are plenty of potential headwinds and downturns for Munich RE here, from slowing growth to ERGO downturns to the simple fact that you can buy peers at far lower valuations, and I’m talking to peers in both insurance and reinsurance. When you can get BBB+ with a 20% minimum capital appreciation upside with a 6%+ yield at 4-5x P/E normalized, you shouldn’t buy a sub-3% yield with an 11% dividend-inclusive upside. This is just my stance and how I invest, but it is, in the end, how I have gone about outperforming the market for several years.

By focusing on valuation.

So for that reason, I’m not all that positive here. I’m raising my target, accepting and reflecting that Munich RE has done its improvements well, and that the forward EPS level likely represents a higher fair value, but I still wouldn’t buy the company at anything close to this price.

Here is my 2024E thesis.

Thesis

• Munich Re is the largest reinsurance company in the world, and also one of the most conservative in existence. It has a double-A credit rating and a set of fundamentals and titanium-clad underwriting processes that make the company a no-nonsense leader in the business.
• The 2Q23 results with forecasts give me pause, and I reiterate my PT here and my stance on HOLD, while considering rotation. The yield is down to less than 3.4%, and I no longer believe you’re in a good position to outperform the market.
• I would give the company a PT of €340/share here, updated for the latest quarterly and outlook. That makes the company overvalued, and I would maintain my “HOLD” rating here.
• An upside is theoretically possible – but I have rotated my shares and invested in more undervalued stocks back in 2023, and this is my updated thesis for 2024.

Remember, I’m all about:

• Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
• If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
• If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
• I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.’

Here are my criteria and how the company fulfills them (bolded).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

Munich Re is no longer cheap or has a sort of realistic upside of 15% or higher based on a price or margin of safety that I would look for. Because of that, it’s a “HOLD”.

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.

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.