This report discusses the possible profitability of investment in shares of the Allianz Group SE. Our analysis, based on discounted cash flows and weighted average cost of capital, suggests that under the assumption of stable economic growth, no drastic escalation of the European sovereign debt crisis and industry shocks due to natural disaster like the hurricane Sandy, the current share price of the company is currently below its estimated value and thus a promising investment opportunity. If the company manages to keep its stable growth in the last quarter of the year, an investment is recommended after a careful analysis of the market changes and the general effect of hurricane-like cataclysms on the industry. Analysis Model
This report includes estimation of the current share price of the Allianz Group SE, based on the Discounted cash flow valuation model, including an estimation for the future growth rate of the company, weighted average cost of capital and equity value estimation, compared to the current market capitalization of the company. Company Overview
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The Allianz Group is a German multinational financial services company, based in Munich, Germany. Active primarily in the insurance market, the company has close to 180.000 employees and 78 million clients worldwide and offers a variety of Life, Health, Property and Casualty insurance products to private and corporate customers. In addition, since 2008 the company owns a 14% controlling stake in the Commerzbank Group. ING, the ANG Group, the AXA Group and the Generali Group are among the biggest competitors of Allianz in the insurance industry.
Similarly to other companies from the industry, adapting to the aftermath of the global economic crisis, Allianz is ready to invest in developing markets: In fact, as presented in Appendix 3, 49,7% of company’s clients are located in so-called emerging markets, featuring estimated growth of 5.5%. (In comparison, mature market like the Eurozone offer an expected growth of only 0.5%.) Industry Outlook
Besides the economic slowdown in the last couple of years there are a series of threats and challenges that need to be considered carefully before an investment decision is done.
Firstly, catastrophe-related losses rose to over USD 100bn in 2011, twice the 2010 level. Various cataclysmic occasions, like the hurricane Sandy that hit the USA at the end of October 2012 often create shocks in the industry, lowering profits. Major floods in New Zealand, Japanese earthquakes and tsunamis and storms in Europe are only a few of the natural disasters threatening the economic progress of insurance companies like Allianz.
Moreover, the sovereign debt crisis in Europe, where almost 50% of the company’s clients reside, creates additional issues with the introduction of the 1% interest rate and global premium falls in the Life Insurance sector create considerable amounts of risks for the future stable growth of the business.
The issues listed above will most definitely affect the growth of the company in the short term. On the positive side, while 2011 was one of the worst years for the insurance industry, the Allianz Group managed to commit a strong 6% growth in its total income: markets in Eastern Europe and the US are growing, emerging markets deliver strong results and so far, the company proves its ability to progress despite the emerging difficulties. Company Evaluation
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Free Cash Flow Estimation
The first part of the company evaluation was focused on the historical performance of the company for the last 5 years and projection of its free cash flow in the future. As presented in Appendix 1, in those years the Allianz Group faced fluctuations in its total income but managed to keep its business profitable, with total expenses averaging around 93% of its Total Income. In terms of growth, the company is expected to grow at a slower pace, 2,4% in 2012 due to the variety of cataclysms faced throughout the year. In coming years however, the strong Real GDP growth of 5,5% in the emerging markets (representing close to 50% of company’s clients), a steady growth of 3,22% is to be expected.
The growing revenues however do not seem to have large impact on the total expenses: the third quarter interim report for 2012 shows lowering expenses, totaling to 91% for 2012. In the coming years however, the rising number of cataclysms and the stagnating economic environment in Europe will most probably increase slightly those numbers and a 93%, a number in line with the incremental changes for the past years. (Appendix 4)
For the sake of the analysis, a conservative effective corporate tax rate of 35,3% from the third quarter interim report has been used. In addition to that, deferred tax losses, presented in the Annual Report 2011 have been added to the calculations of future cash flows.
Historical analysis (Appendix 1) and projection for the year 2012, based on the third quarter interim report (Appendix 4), reveal solid and unchanging values for the working capital, depreciation and amortization and capital expenditure, 9%, 1,1% and 1,3% correspondingly – values not affected despite the company’s grow in emerging markets.
The assumptions listed above helped for the outlining of a percentage-of-sales free cash flow projection, presented in detail in Appendix 6 and 7.
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Cost of Equity, Cost of Debt, WACC Calculation
The cost of Equity Calculation was based on the Capital Asset Pricing Model, using the 10-Y German bond value of 1,37% as risk-free rate. In addition, a market risk premium of 7%, used for the risk premium estimation during the Financial Management classes at GISMA Business School, had been part of the calculations.
The calculated Cost of Equity of 10,26%, the cost of debt of 2,36% and market valuation of the capital structure of Allianz (54,5% Debt, 45,5% Equity), described in detail in Appendix 8, allowed the calculation for the Weighted Average Cost of Capital, 5,95%, needed for the present-value equity evaluation, on the basis of which this analysis is being conducted.
The capital structure analysis revealed as well target capital structure values of 45% debt and 55% equity, numbers closer to the book valuation of the capital structure. The book valuation however has not been used due to its emphasis on historical weights, and instead, the market valuation’s estimation of capital on continuous basis has been preferred and selected for the WACC calculation. Discounted Cash Flows and Company Evaluation
Appendix 9 shows the last steps of the company evaluation conducted: calculation of the present value of the projected cash flow from Appendix 1, using the defined WACC rate. Discount cash flows were calculated for the years 2012-2017, with addition of the terminal value of the Allianz Group, using the growing-perpetuity method. The analysis conducted defined an estimate for the total enterprise value of Allianz – 84 430 mln.€.
Finally, the result, after being adjusted for company’s cash and cash equivalents, investments and debt, was divided by 495,95 mln. shares outstanding, providing a final stock price valuation of 143,3€. Sensitivity Analysis
Due to the high difference between the current stock price and the estimated one, a sensitivity analysis on the fluctuations of cost of equity, cost of debt and growth was made. The analysis, presented in Appendix 10, reveals the critical values, the value for which an investment in the Allianz stocks will not be profitable: 13,26% for cost of Equity. Similarly, if the cost of debt goes above 4,36% or the growth stagnates to 1,22%, winnings will be marginal.
Final Recommendations
The analysis conducted above shows that the current market price of Allianz Shares -99,93€ – is below its market evaluation of 145,03€ and thus a profitable investment opportunity. It is important to point out however that this analysis was based on stable growth model in line Real GDP growth and thus rather optimistic. The more conservative approach would place the expected growth rate at 2,22%, 1% below the GDP growth. This safe scenario still gives us an estimated share value of 114,8€. This conservative scenario proves that investing the shares of the Allianz group is a chance, which should be taken after careful analysis of the annual report 2012, coming at the end of January, 2013. If the company manages to keep its growth despite the bad results following the hurricane Sandy, an investment is advisable.
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