One investor in small cap insurer Calliden describes its business as analogous to “selling straw hats in the middle of winter in Alaska”...and the group's 20 per cent fall in the past two months underlines his point.
This same investor is definitely one of life's true optimists (for one thing, he doesn't think climate change is a threat). But he knows that in the main, more money is made from optimism than from doom and gloom. He also knows a good punt when he sees one.
Calliden is one of the best run insurers in Australia, if not the world. In early 2005 it emerged from the ashes of Reinsurance Australia or Reac. It now provides general insurance for trades people and builders, sports clubs and Ferraris.
The company's shares were above 60 cents in 2007 when it was writing $124 million in gross premium and producing a $1.3 million net profit. Fast forward to today and Calliden's stock is about 20 cents, but it's writing well over $200 million in premiums and last year produced a net profit of $10.1 million and a dividend of 1 cent.
But now we get to the real business of insurance. Like other insurers, it has been hit by the unprecedented run of natural disasters. Of these, Calliden (ASX code CIX) has been exposed to the floods in Queensland, the severe tropical cyclone Yasi in that state's north, and the flash flooding in Melbourne. (Pessimists, and not a few scientists, see climate change exacerbating such weather extremes.)
It says that the hit this calendar year from these events will be between $5 and $7 million.
If you don't include this loss, or any more calamities, its profit for calendar year 2011 should be in the region of $12.5 million, delivering it chief executive Nick Kirk's prediction of 12.5 per cent return on equity. Suncorp, which writes over $7 billion in premium revenue and has a banking business, last year achieved a return on equity of just over 6 per cent.
Kirk says he is under no illusion that these events represent an excuse for not making the target, but he is optimistic (yes, another optimist) that assisting his company's returns will be continuing increases in premium rates. This means customers will be paying more for insurance.
This increase includes the insurers themselves. Next month, all eyes will be on the renegotiated re-insurance rates for insurers with 30 June year ends, which includes Suncorp. Kirk says that the increased cost of insurance will lead to even bigger premium increases.
In the end, if you are a believer that not enough is being done to combat climate change, Calliden might not be for you. But the company is well funded and has few borrowings. It is also able to take advantage of both rising premium rates and rising interest rates (it holds most of its reserves in bank deposits).
And as our climate change denying investor says: “insurance is like a bookie shop, and these guys are smart.”
Investors in Clover
Another company whose shareholder base would be considered optimists, is nutritional supplement provider Clover.
Patience is definitely a virtue when it comes to investing in this minnow, which has a market cap of just under $48 million. At 15 cents, Clover's shares have declined about a third since the end of 2010. Although since current chief executive Ian Brown took over about four years, Clover has doubled its revenues and its share price, even after the recent weakness.
The company (ASX code CLV) has an “encapsulation” technology, which it developed with the CSIRO. This means it can convert things like fish oil which contains valuable vitamins such as omega-3 into powder. This is valuable for the big producers of infant milk formulas because it increases the shelf life of their products and means that they don't require refrigeration.
The big market is Asia where standards of living are improving and sales of formula are growing at 10 per cent a year. Clover derives about 70 per cent of its $34 million or so in sales from this region.
The share price weakness is mainly a reflection of investors' impatience that the products that are coming on line haven't yet boosted sales, and this is acknowledged by Brown.
“It takes our clients between two and four years to develop products using (Clover's technology).”
These customers are multinationals, including Mead Johnson and the road testing they need to do includes shelving the product for as long as 12 months.
Investors' short-term impatience could mean an opportunity. In Clover's favour is that it has quite a number of ducks lined up. It has launched six products this year and has another three slated for next year.
Brown has said that the six new products will add revenues of $25 million a year over the next three years. Pegasus Securities' analyst Michael Brown thinks this will be closer to $32 million and has a 53 cent valuation (based on discounting forecast cash flows) to boot.
For the optimists, this stock could be another worth holding on to.
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