October 19, 2010 by HESTER PLUMRIDGE
When Warren Buffett writes a check, the world peers over his shoulder. The veteran investor’s decision to raise his stake in Munich Re, the world’s largest reinsurer, from 3% to more than 10%, is a case in point. The reinsurance industry may be challenged by soft pricing and low investment income, but it’s rarely looked so cheap. Even if catalysts for a re-rating look thin on the ground, Mr. Buffett can afford to take the long-term view.
Reinsurers face some chilling winter winds. Low bond yields and cash returns have slashed investment income; the stock market is spooked by regulatory uncertainty. After 2009’s equity market recovery and low incidence of natural disasters, the industry was left with excess capital, which losses from Chile’s earthquake and the Deepwater Horizon oil spill haven’t dented. Overcapacity is depressing prices. Even in flood-ravaged Poland, insurers think they can stave off reinsurance premium increases next year.
But longer-term dynamics look more favorable. A big disaster on the scale of a 9/11 or a Hurricane Katrina could wipe out capital and weaken smaller players, as well as boosting pricing. Uncertainty over future regulation won’t last forever. Valuations are already low. Reinsurers currently trade around tangible net asset value, and Munich Re at just 0.95 times, well below the sector’s 1.2 times recent average.
Shareholders are also benefiting from strong balance sheets via dividends and buybacks. Munich Re yields a prospective 5.6% for 2010, estimates Credit Suisse, high relative to the market, and above closest peer Swiss Re. Munich Re’s share buyback program, initiated May, targets a €1 billion ($1.4 billion) repurchase by April 2011. Strong cash generation suggests this could be extended next year, and dividends maintained or increased.
Mr. Buffett’s interest in reinsurers is longstanding. Berkshire Hathaway acquired top 10 global firm General Re in 1998; in 2008 it took a 3% stake in Swiss Re. Munich Re investors will hope that, in Mr. Buffett’s words, “time is the friend of the wonderful company”. Mr. Buffett certainly seems to have faith.
Write to Hester Plumridge at Hester.Plumridge@dowjones.com
Source: Proshare
