Tower reported a strong result ahead of market expectations. The Health Insurance business performed strongly with the key driver being price increases offsetting a declining market. Product changes have also lowered claims costs and Tower continues to write a good level of new business.

In the General Insurance business, despite its Christchurch exposure, the business delivered a good performance. Home premiums have risen by around 25% and are helping to offset rising re-insurance costs. In the funds management division, KiwiSaver inflows continue to be good rising 33% year over year.

Across the entire business Tower is continuing to make operational improvements and is pursuing a number of growth initiatives to drive organic growth.

There were a couple of negative surprises in the result. The total cost of the IT system upgrade has been revised upwards again and now stands at $45m. The benefits of the upgrade of around $3m a year, will now only contribute in the 2013 financial year. This is a further delay and cost blow out from a disappointing IT project.

Secondly, the dividend was cut to 2 cents per share despite Towers net cash position improving; we believe this signals that the board maybe retaining funds for the potential acquisition of AMI which would cost around NZD160m.

How positive an acquisition of AMI would be will depend on a number of factors. The main one being the price of the acquisition and how the company would fund it. It may be hard to debt fund an acquisition in the current climate which means the company would have to raise capital. The other consideration is whether the government will ring fence AMI’s Christchurch exposure. In terms of business fit, AMI would fit well with Towers existing businesses.

 GPG is the largest shareholder with a 35% stake and GPG intends to divest its stake in Tower, which could trigger a full or partial takeover. We think that if Tower were to acquire AMI then potentially one of the Australian Insurance companies would look to buy Tower.

Tower has net cash of $71.6m and has assessed its exposure to the Christchurch Earthquakes at $450m, although the company believes the cost could be less than this number, which is well inside the cap of existing re-insurance arrangements. Gearing is conservative at around 15%. Overall the company’s financial position is looking more than adequate and their balance sheet is quite conservative.

Towers valuation looks undemanding at the moment with potential catalysts for the share price to re-rate. It is a deep value play and also we are currently at the trough of the insurance cycle. We have a positive view for the future of the company.

Mark Warminger
Disclosure of interest: Milford is a shareholder of Tower through our Funds