Tuesday, 18 October 2016

Tesco Grows Its Market Share For the First Time in 5 Years

The supermarket giant’s turnaround plan appears to be working.

Tesco grew market share for the first time in five years over the last three months, the clearest sign to date that Britain’s biggest supermarket chain is recovering from years of turmoil to accelerate away from rivals.
"Tesco has attracted a further 228,000 shoppers through its doors to help the grocer grow to a 28.2% share of the market – its first year-on-year market share gain since 2011,” said Fraser McKevitt, head of retail and consumer insight at Kantar Worldpanel.

“Sales growth has been strongest among family shoppers, while improved trading from its larger supermarket and Extra stores has supported this month’s gains.”
Tesco shares traded up 2% to 205 pence, outperforming Britain’s bluechip index which was trading 0.8% higher.


Thursday, 13 October 2016

Interesting Donald Trump tough Interview

Trump versus Clinton: The issues in US election.

Trump Panama City Florida

FULL EVENT: Donald Trump 30K Rally in Panama City, Florida 10/11/2016 Trump Live Panama Speech

Warren Buffett's US Federal Tax: Are you surprised or amazed by the amount of US Federal tax paid by Warren Buffett?

Warren Buffett released his US Federal tax returns.

He reported an income of about US 40 million and paid about US 2 million last year.

I am surprised by the small amount of reported income and Federal tax he paid relative to his actual wealth in the US billions of dollars.

However it is all legal within the tax code.

He receives US 100,000 a year in salary for managing Berkshire Hathaway.

This too places him in a lower tax bracket.

This US election has provided insights into how the rich uses the tax code to pay the minimum amount of tax legally.

The tax code should be revamped to seal up all the loop holes and simplified too.

The tax accountants are doing a great job reducing the taxes of the super rich.

It is not illegal but is it fair and reasonable?  

Wednesday, 12 October 2016

Top Glove achieved another record performance despite intense competition

Top Glove CorporationBhd


Group achieves historical highs in Revenue and Profit

Shah Alam, Wednesday, 12 October 2016 – Top Glove Corporation Bhd (“Top Glove”) today announced its results for the Fourth Quarter (“4QFY16”) and full year ended 31 August 2016 (“FY2016”), marking yet another record year, with historical highs in both full year Revenue and Profit.

Posting another outstanding performance for the financial year 2016, the Group attained its highest Revenue ever of RM2.9 billion, an increase of 15.1% over FY2015. Meanwhile Profit Before Tax and Profit After Tax each also registered record highs, at RM442.6 million and RM362.8 million,
respectively representing an upturn of 21.8% and 29%. Volume (quantity sold) was also at an all-time high, notwithstanding intensifying competition and pricing pressure.

The robust set of numbers was attributed to several improvement initiatives which have proven instrumental in enhancing quality and cost efficiency, the twin pillars of Top Glove’s time-tested success formula. A stronger USD, as well as lower raw material prices earlier in the financial year, also boosted the Group’s performance.

For 4QFY16, the Group achieved Revenue of RM722.1 million and Net Profit of RM65.8 million, delivering growth of 7.4% and 4.8% respectively, compared with 3QFY16, notwithstanding intensive competition and cost increases stemming from hikes in minimum wage, as well as the natural gas tariff.

On a year-on-year comparison, 4QFY16 results were relatively softer, with a marginal increase in Revenue of 1.8%, while Profit After Tax declined by 36.2%. The less favourable comparison came on the back of a challenging environment in 2HFY16, as tailwinds from 1HFY16 gradually turned to
headwinds. Increased competition in the second half of the financial year also led to a downward revision of the average selling price, while volatility in raw material prices and forex created a mismatch in the cost pass-through system.

On Top Glove’s performance, its Executive Chairman, Tan Sri Dr Lim Wee Chai remarked, “We have done well in FY2016. Amidst a challenging business environment with substantial cost increases and intense competition, we have achieved another record performance and our best year yet!” “This is a credit to the internal quality and efficiency enhancements we have been implementing continually, as well as our management team and staff, who have worked hard to ensure we deliver a performance worthy of the Top Glove name” he added.

Top Glove which celebrates its 25th anniversary this year, remains on expansion mode. The Group completed the expansion of Factory 27 (Lukut) in August 2016 while the expansion of Factory 6 (Thailand) is expected to be completed by November 2016. Meanwhile, in progress is the construction of a new facility, Factory 30 (Klang), expected to commence production by April 2017, by which time Top Glove will have a total of 540 production lines and a production capacity of 52.4 billion pieces of gloves per annum. With a view to expanding its production capacity, the Group also recently acquired a factory in Klang (Factory 31). The facility is estimated to be able to produce 6 billion pieces of gloves per annum, with Phase 1 targeted to be operational by mid-2017. Top Glove will continue to pursue M&A opportunities that synergise with its current business, both in similar or related industries.

On 28 June 2016, the Group successfully completed its secondary listing on the Mainboard of the Singapore Exchange, an exercise undertaken to add and create value for its shareholders and stakeholders.

Honouring its commitment to enhance shareholder value, the Board of Directors has proposed a final dividend of 8.5 sen, bringing the total FY2016 dividend payout to 14.5 sen, subject to shareholders' approval at the upcoming AGM in January 2017. This represents a 26% increase in dividend per share compared with the previous financial year and a dividend payout ratio of 50.3%.

As at 31 August 2016, the Group also maintained a healthy balance sheet and a positive net cash position of RM303.7 million.

Top Glove foresees a competitive business landscape ahead, with the likelihood of oversupply and eventually, industry consolidation taking place. However, the Group is confident of overcoming any challenges that may arise by enhancing its cost management and optimising the efficiency of its production lines. The Group views the potential consolidation as an M&A opportunity.

Notwithstanding its commendable results, Tan Sri Dr Lim asserts, “We do not take our achievement for granted. Continuous improvement in quality and efficiency is our duty and an ongoing journey for us. This will ensure we stay healthy and competitive for another 25 years and beyond”.


Sunday, 9 October 2016

Investing in economic moats. A lot of investors wasted time on margin of safety and suffered a large opportunity cost.

Overestimating and Underestimating an Economic Moat

For those who invest into economic moats, be mindful of two possibilities.

1.   Overestimating a moat:  

This means (over-)paying for value creation that will never materialize.

2.   Underestimating a moat:

This means there is a large opportunity cost.  

On finding a good business opportunity, invest in it as it is going to compound at high rate.  

This avoid the suffering of opportunity cost.

Wasting time on margin of safety and not a lot on opportunity cost is the problem of a lot of investors.

Moats matter in a long run.

Most of the investors own securities for a short period of time.

Moats matter in a long run.

Most investors focus on short-term changes in price and not long term changes in moats.

Finding moats means finding efficiency of business.

Quantitative versus Qualitative factors

The quantitative data in market tends to be very efficiently priced.

Qualitative insight is understanding the structural characteristics of the business.

All the information is in the past, but all the value is in the future.

The future value creation will come from the things you see today and not necessarily the information that occurred in past.

The economic moats have a significant effect in keeping the organizations at the top and it is a good defense of an organization against competitors.


Investing in Economic Moats

High profits attract attention which makes more people invest.

As a result,the profit of companies decreases over time for most of the companies as competition comes in.

There are companies who defy economic gravity by creating structural advantages, economic moats.

The moats insulate and buffer them against competition.

Thus, they keep super-normal returns on capital for a longer duration.

Insight of intangible assets having effect on Moats

1. Brands

Being well known is not sufficient.

There needs to be a change in the consumer behaviour by increasing the willingness to pay or reducing the search costs thus resulting in the increase of the value of the company.

2. Patents

Despite being legal, they are subject to expiry, challenge and piracy.

To rely on patents as a moat there is need of portfolio of them as it is hard to invalidate one or the other.

3. Licenses/approvals

It is not easy to get a license or approval and it serves as a solid moat.

Restraints to try new businesses

1.  Switching cost effect

Switching to competitive products is expensive and time-consuming.

Service relationships can be sold in the form of maintainance by attaching a service to the product.

By providing high benefit to cost ratio, it is more beneficial when switching business is being looked for.

2.  Network effect

There are two types of networks - radial and interactive.

Radial networks are less effective and robust.

By providing the service that increases the value of the company as the number of users expand and aggregate demand is increased between parties scattered at different places.

As soon as the number of nodes and connections is increased the network becomes hard to replicate thus becoming a strong moat.

3.  Cost Advantages

Process:  By inventing a cheaper way to deliver a product that cannot be replicated quickly.

Scale:  Spread fixed costs over a large base.  Relative size matters more than absolute size.

Niche:  Establish minimum efficient scale.

Role of Management

Management plays an important role in moats.

Managerial skills are inversely proportional to the quality of business.

Good managers look for ways to widen the companies moat.

Bad managers invest capital outside company's moat.


Advantages of Moats. Moats matter a lot as it adds to the intrinsic value of the company.

Advantages of Moats

Moats can buffer the mistakes of management and save the business from complete disaster because the business was strong and robust (e.g. Microsoft and New Coke).

Local differences can create moats.

Foreign companies are not allowed to own banks thus allowing Canadian banks to be more profitable.

Minimum efficient scale is more common as big companies may not invest in small businesses thus giving complete ground to the small companies.

Cultural preferences matter a lot since the things famous in one country might not do well in another country (e.g. food products), thus allowing these businesses to build moats around them.

Moats matter a lot as it adds to the intrinsic value of the company.

A firm which can compound cash flow for many years has more worth than the firm which cannot.

Companies with no moats, capital comes down fast, as compared to the companies with greater moats.

The value of an economic moat is also largely dependent on reinvestment opportunities.

The ability to reinvest a lot of cash at high incremental ROIC would make it a very valuable moat.

If a firm has little ability to reinvest it would add a little to the intrinsic value of the moat.

Moats are not limited only to big companies.

Moats are beneficial in creating stability and building confidence.

Role of Management

Management plays an important role in moats.

Managerial skills are inversely proportional to the quality of business.

If the business is good, an average management would also do fine.

For bad business, a good manager is required.

Good managers look for ways to widen the companies moat.

Bad managers invest capital outside company's moat.

There are exceptions where a good manager can do good in bad businesses.


Thursday, 6 October 2016

Scientex matches products with markets to boost sales

September 27, 2016, Tuesday


Industrial and Consumer Packaging Products

Scientex Bhd (Scientex) has started to make in-roads into new markets for both its industrial and consumer packaging products based on different marketing strategies adopted for specific markets to boost sales demand.

“The group continues to emphasise on quality products and to this end, the ongoing upgrading of facilities and commissioning of new machinery in its Rawang, Pulau Indah, Ipoh and Melaka plants,” the group said in releasing its results yesterday.

“Further, to remain competitive in the global market place and as part of its on-going efforts to boost (profit) margins, the group has taken pro-active steps to enhance its operational efficiency through its continuous efforts to reduce cost and wastages.”

Additionally, the group’s brand new castpolypropylene (CPP) plant is slowly building up its production capacity to meet the demands of its customers whilst the group’s brand new state-of-the-art multi-million biaxially oriented polypropylene (BOPP) film manufacturing plant at Pulau Indah has started testing and commissioning works since July 2016 with full commissioning and commercial operation slated by the second half of the year.

“The group is confident that given the strategies put in place, demand from both local and overseas for its industrial and consumer packaging products is expected to be positive for the coming financial year as it offers quality products with a wider and diversified product portfolio to its expanded global customer base,” Scientex said.

Property Division

Moreover for the property division, Scientex believed the group’s performance for the quarter ended July 2016 was focused primarily on affordable homes in Pasir Gudang, Senai and Kulai projects in Johor where demand remained resilient and robust.

For the quarter ended July 2016, Scientex noted the group was on track and launched its latest Pulai land development which was successfully acquired in early 2016.

“The phenomenal demand for its initial two maiden launches under this development has given a strong boost to the group and plans are underway to tap the huge demand for such affordable homes within the vicinity of this region.

“One of its main attraction is the construction of a new link road by the group that has improved connectivity and accessibility to Gelang Patah, Johor. The upcoming completion of the proposed Kangkar Pulai Interchange to the SecondLink has also boosted the viability and location of this development,” the company observed.

Apart from that, the group also seek to address rising constructional costs by incorporating innovative designs, blending with the environment and tapping operational efficiencies to reduce costs and wastage.

Scientex said its township development projects were all well designed to optimise the use of land space through efficient land usage, density and systematic execution of works to boost operational margins and reduce financing costs through better cash flow management and timing of its launches.

The company noted the group is making preparations for the launch of its two pieces of lands in Ipoh of which vacant possession for its Klebang land has been taken over recently and poised to be launched in the first or second quarter of the coming financial year.

The Meru land acquisition is expected to be completed in September with a maiden launch to be held thereafter, further boosting the sales of the group from these new projects over the medium and longer term.

The group foresees the affordable housing segment will continue to play a pivotal role in contributing to the group’s top and bottomline for the coming financial year.


Scientex’s 4QFY16 earnings up 11 per cent to RM54.14 million, revenue grows to RM561 mln

September 27, 2016, Tuesday

KUCHING: Scientex Bhd’s (Scientex) earnings for the fourth quarter of 2016 (4QFY16) ended July 2016 gained by 11 per cent year-on-year (y-o-y) to RM54.14 million from RM48.91 million recorded in 4QFY15 ended July 2015.

The company in a filing to Bursa Malaysia yesterday said 4QFY16 revenue grew by 24 per cent y-o-y to RM561.06 million from RM452.49 million in 4QFY15.

Scientex noted the improved revenue for 4QFY16 was attributed to higher sales from its property division.

The company in its accounts notes said property revenue recorded in 4QFY16 was RM188.4 million as compared with RM132.6 million in the preceding year corresponding quarter, an increase of 42.1 per cent.

The increase in revenue for the property division was contributed by the steady construction progress and new sales achieved from projects in Johor and Melaka.

However, Scientex noted profit from the division’s operations was lower at RM58.2 million as compared to RM61.5 million in the preceding year corresponding quarter due to product mix for the new project launches in Pasir Gudang, Johor.

Additionally, Scientex shared that its manufacturing revenue increased by 16.5 per cent y-o-y for 4QFY16 to RM372.7 million as compared with RM319.9 million generated in 4QFY15.

The company explained that the increase was attributed to higher contribution from the consumer packaging products as well as contribution from the newly acquired Scientex Great Wall Ipoh Sdn Bhd.

Earlier, on August 5, 2015, Scientex announced that its wholly-owned subsidiary Scientex Packaging Film Sdn Bhd (SPFSB) had entered into a share purchase agreement with Mondi Consumer Packaging International GmbH to acquire Scientex Great Wall (Ipoh) Sdn Bhd for RM58 million with the transaction completed on August 11.

However, Scientex said its operational profit from the manufacturing segment decreased to RM15.9 million from RM24.8 million due to lower product profit margins.

For the full financial year 2016 (FY16) ended July 2016, Scientex said revenue rose by 22 per cent y-o-y to RM2.2 billion while net profit jumped by 52 per cent y-o-y to RM240.87 million.

Scientex noted that the improved profit was attributed to better sales achieved for both the property and manufacturing


Mixed feedback on Genting Malaysia selling stake in HK branch

October 5, 2016, Wednesday

KUCHING: Genting Malaysia Bhd (Genting Malaysia) latest move in disposing of the group’s entire 16.9 per cent stake in Genting Hong Kong Limited (Genting Hong Kong) has garnered mixed reactions from analysts.

In a filing on Bursa Malaysia, Genting Malaysia announced the group’s disposal of 1.43 billion ordinary shares in Genting Hong Kong, representing 16.87 per cent of the then total issued and paid-up share capital of Genting Hong Kong, for a total cash consideration of US$415 million or the equivalent of approximately RM1.71 billion.

According to the research arm of Kenanga Investment Bank Bhd (Kenanga Research), although this is a related party transaction (RPT), it is a positive move as the non-core stake in Genting Hong Kong has not much impact on Genting Malaysia while the disposal proceeds can be better applied for the latter’s expansion program, such as the RM10.38 billion Genting Integrated Tourism Plan (GITP) development.

“In fact, Genting Hong Kong used to be a wildcard and impacted Genting Malaysia badly in which the latter owned more than 20 per cent stake, which qualified for equity accounting.

“However, since Genting Malaysia reduced its stake to below 20 per cent in 2007, the impact from Genting Hong Kong became immaterial,” Kenanga Research said.

While the announcement did not disclose the disposal gain/loss of this divestment, Kenanga Research believed the impact was small given that the Genting group always reported mark-to-market value on their investments in listed companies on a quarterly basis.

However, the research arm made adjustments to its earnings model to reflect this disposal as the proceeds will affect interest income while it has also made upward adjustment on Genting UK and the North America earnings following their strong numbers in the first half of 2016 (1H16).

In all, the research arm upgraded financial year 2016 estimate (FY16E)/FY17E earnings by eight per cent/six per cent.

In contrast, the research arm of Hong Leong Investment Bank Bhd (HLIB Research) was neutral on this disposal as it is a RPT and the disposal price of US$0.29 is at the minimum price allowed under the mandate (in spite at a 8.2 per cent premium to five days volume weighted average market price (VWAMP)) compared to the average purchase cost of US$0.42.

HLIB Research noted that this disposal allows Genting Malaysia to monetise the group’s loss-making investment in Genting Hong Kong which provides minimal income yield (total dividend received RM106 million versus total investment of approximately RM4.12 billion since 1998)!!!!!!!!!!!!.

“The proceeds of RM1.71 billion can be put into better use for its working capital and capex for its expansions, while maintaining net cash position,” the research arm said.

The research arm further noted that having classified the investment as assets held for sale since year 2015 with a carrying value of RM1.74 billion, there will be a one-off accounting gain on disposal of circa RM1.23 billion after the reclassification of reserves (previous year revaluation and foreign exchanges gain/losses).

On another note, HLIB Research said that potential loss of dividend income from Genting Hong Kong is rather negligible given the inconsistency of dividend payment and the quantum.

Dividend received in FY15 was about RM56 million, which was circa 3.8 per cent of the research arm’s FY16 forecasted profit after tax and minority interest (PATAMI).

“This level of yield can be easily recouped from interest bearing deposit or interest savings from the proceeds,” it said.

Forecast-wise, HLIB Research imputed the effect of the disposal into its balance sheet ignoring the one-off gain/loss/reversal arising from the transaction with no change in earnings.

“We opine that growth in 2017 on higher visitors from the amenities under GITP has been largely priced in, impending for more exciting catalysts in 2018.

“Meanwhile, we are still wary on the uncertain overseas operations, the potential risks in execution and the high cost involved,” the research arm said.


German minister accuses Deutsche Bank of making speculation

October 4, 2016, Tuesday

TEHRAN: German Economy Minister Sigmar Gabriel accused Deutsche Bank on Sunday of blaming speculators for last week’s plunge in its share price when the bank had itself made speculation its business.

“I did not know if I should laugh or cry that the bank that made speculation a business model is now saying it is a victim of speculators,” Gabriel told reporters on a plane to Iran, which he is visiting with a business delegation.

Deutsche, which is Germany’s largest bank and employs around 100,000 people, has been engulfed by a crisis of confidence after the US Department of Justice handed it a demand last month for it to pay up to US$14 billion to settle claims that it missold US mortgage-backed securities before the financial crisis.

The threat of such a large fine has pushed Deutsche shares to record lows and a deal at a much lower price is now urgently needed to reverse the shares sell-off and help to restore confidence in Germany’s largest lender.

Chief executive John Cryan on Friday tried to reassure staff of the bank’s financial strengths in a letter which warned them that “new rumours” were causing the share price to fall and that there were “forces” that wanted to weaken confidence in the bank.

Gabriel, who is also leader of the Social Democrats (SPD), the junior partner in Angela Merkel’s coalition government, said he was worried about those who were employed by the lender.

The problems of Deutsche Bank are awkward for Berlin, which has berated many euro zone peers for economic mismanagement and taken a hard line on other EU nations giving state aid to bail out their problem banks.

Last week the German finance ministry moved swiftly to dismiss a report that a government rescue plan was being prepared in case Deutsche Bank was unable to raise sufficient new capital to settle litigation which includes cases dating back to its expansion before the financial crisis.

With Germany facing elections next year, there is little political appetite for helping a group disliked by many Germans because of its investment bank’s pursuit of business abroad that resulted in incurring billions of euros of penalties for wrongdoing.

— Reuters

Scientex’s FY17 earnings outlook remains promising

October 3, 2016, Monday

KUCHING: Scientex Bhd’s (Scientex) financial year 2017 (FY17) earnings outlook has been viewed as promising, following a results briefing at the newly constructed biaxially oriented polypropylene (BOPP) plant in Pulau Indah.

According to RHB Research Institute Sdn Bhd (RHB Research), Scientex’s highly anticipated BOPP film plant, which would raise capacity ten-fold to 60,000 tonnes, come into operation in September.

“The new plant was part of a strategic alliance with Futamura to employ advanced Japanese film-manufacturing technology to produce high-quality BOPP films.

“As we understand, the BOPP film supply landscape in Malaysia presents promising market potential for Scientex, as the bulk of local demand for BOPP film is currently imported.

“Secondly, its state-of-the art BOPP facility would allow cost-efficiencies to ensure price competitiveness, while offering high quality films that local competition may lack,” the research house said.

On Scientex’s property division, RHB Research noted that new property sales rose a solid 30.8 per cent year on year (y-o-y) to RM794 million in financial year 2016 (FY16) (July).

“Management has plans to launch projects worth about RM700 million in FY17, after achieving targeted launches of approximately RM650 million in FY16.

“Going forward, management plans to direct its focus on affordable housing below the RM500,000 per unit mark, where demand for housing remains resilient,” the research house said.

It added that unbilled sales stood at RM717.2 million in FY16, compared to RM584.9 million in FY15, and would provide earnings visibility for the next few years.

Meanwhile, the research arm of TA Securities Holdings Bhd (TA Research) highlighted that# for the property segment, the group is looking to complete the Meru land acquisition in September 2016 with maiden launch to be held in the second quarter of 2017 (2Q17).

“This will help to boost the sales of the group from these new projects over medium to longer term,” TA Research said.

TA Research noted that the group will be focusing on improving efficiencies by reducing costs and wastage.

The research arm further noted that this could be achieved through better planning and systematic execution of works, coupled with better cash flow management to lower the financing cost.

After imputing FY16 results, TA Research tweaked its FY17-FY19 earnings estimates slightly upwards by 1.8 per cent/-2.1 per cent/0.9 per cent to RM311.4 million/RM363.1 million/RM379.3 million respectively, following some changes in key assumptions (which are revenue and operating expenditure (opex).

All in, TA Research maintained ‘buy’ on the stock.

On the other hand, RHB Research kept its FY17 to FY18F earnings relatively unchanged and introduced its FY19 projection.

It also maintained ‘buy’ on attractive valuations and exciting growth plans in Scientex’s manufacturing segment.


Security Commission proposals push REITs in the right direction

September 30, 2016, Friday Ronnie Teo

KUCHING: Analysts laud the Securities Commission’s (SC) consultation paper to revise its guidelines for Malaysian Real Estate Investment Trusts (M-REITs) seen as a positive step in the right direction.

The guidelines aims to enhance M-REITs’ growth by broadening the scope of permitted activities, improve governance to safeguard investors and maintain long-term sustainability, and increase efficiency by streamlining post listing requirements.

The main highlight is Proposal 1 for Property Development Activities, which essentially allows M-REITs to undertake greenfield development subject to the development not exceeding 15 per cent of the REITs enlarged total asset value (TAV) in aggregate, thus capping the exposure to development risk.

“All in, we are positive on Proposal 1,” highlighted researchers with Kenanga Investment Bank Bhd (Kenanga Research).

“Although there is no accretion to earnings in the near term, and is only earnings positive in the longer run, we expect news flow on greenfield development to bode well for share price sentiment and valuations.

“We view Proposal 1 positively as it allows REITs to grow earnings given limited opportunities for accretive acquisitions in the current low cap rate conditions.

Kenanga Research observed that current cap rates for retail assets range between four to six per cent, while the rate was between six to eight per cent for industrial assets.

“M-REITs would be able to own assets at lower capital outlays; essentially, the real return on investment on development cost will be better than buying already completed buildings, which are based on market value with lower asset financing cost.

“Additionally, there is the icing on the cake when the greenfield development is completed, arising from revaluation exercise to reflect market valuation, which will further boost their asset and book value without additional cash-outlay.

“This opens the door of opportunity for M-REITs’ earnings growth in the longer run and will help alleviate the burden of low cap rates plaguing the market currently, but the impact to earnings is expected to be neutral in the near term, and accretive only in the longer run post construction.”

It is also important to note that the new guideline stipulates that the REITs would have to hold the assets for a minimum of two years post development, making it unlikely for the REIT to take on development unnecessarily unless there is a clear demand for it.

“We believe industrial REITs would be the main beneficiary. Although all M-REITs would be able to benefit from Proposal 1 by gaining higher development cost yields, we believe industrial REITs may fare better as development cost for industrial assets may be cheaper than retail, while it would also be easier for industrial MREITs such as Axis REIT to find a pre-committed tenant as it can operate on fewer tenants or a single tenant basis,” it said.

“To note, retail M-REITs require multiple tenants and may not be able to secure a pre-commit during or before construction. As such, retail M-REITs have greater leasing risk, which we believe can be mitigated should the REITs have extensive tenant network to leverage on.”

The firm was all in positive on SC’s list of Proposals, as it expect news flow related primarily to Proposal 1 to 4 to bode well for share price sentiment and valuations, with minimal impact to earnings in the near term.

“Besides Proposal 1, Proposals 2 to 4 are expected to be beneficial to unitholders as it is catered towards facilitating earnings growth by increasing the scope of permitted activities by M-REITs, making it easier for them to secure tenants or minimise vacant space,” it added.

Proposal 5 on unit buy-backs aims to lend stability to share price and is a form of returning cash to unitholders, while Proposal 6 will help limit balance sheet risks amidst increased exposure to property development.

“Proposals 7 to 10 are catered towards enhancing governance and transparency which we view positively as it will benefit shareholders as it aims to protect shareholders and ensures the sustainability of M-REITs without burdening the managers.

“Additionally, Proposal 11 (revaluation of assets) which is also targeted at enhancing governance, requires the REIT to revalue its assets once every financial year versus once in three years previously, which we view as neutral impact to unitholders.

“Although frequent asset valuations capture the assets current market value which is beneficial for transparency to unitholders, asset revaluations do incur additional costs, while volatile property market conditions may affect capital values of the assets, and may negatively impact the REITs gearing ratio,” it added.

Proposals 12 to 13 are geared towards streamlining post listing requirements allowing MREITs to be on par with other listed corporations, including the process for rights issuance which is currently longer and more arduous for M-REITs.

Other proposals include Proposal 14 (Property Management) will be beneficial to investors and managers as it aligns the interest of the REIT Manager with the property manager.

Proposal 15 (Internal Management) will be beneficial to investors as it forces the existing REIT manager to perform, while failure to do so will allow a ‘Change of the REIT Manager’ (Proposal 9), giving shareholders the option to remove the existing manager and allow the REIT to be managed by hiring executives to internally manage the REIT.

Lastly, Proposal 16 which limits the offer of unlisted REITs to Sophisticated Investors aims to protect investors that do not have privy access to information to invest in an unlisted REIT.


Scientex starts operations of Malaysia’s largest BOPP film manufacturing plant

September 30, 2016, Friday

KUCHING: Global packaging manufacturer Scientex Berhad (Scientex) yesterday inaugurated operations of its new BOPP film manufacturing plant – the largest such facility in Malaysia in Pulau Indah, Selangor.

The new plant, boasting an annual production capacity of 60,000 metric tonnes (MT), was constructed in collaboration with Futamura Chemical Co., Ltd (Futamura), a leading plastic films manufacturer and the largest BOPP film manufacturer in Japan.

The plant was built at a cost of RM220 million, and is equipped with state-of-the-art machinery from Japan Steel Works Ltd, capable of wider-web and higher-speed film production.

The plant was officially opened by Deputy Minister of International Trade and Industry Datuk Ahmad Maslan in the presence of consular representative of Japan in Malaysia Kohei Nakamura, and Futamura president Yasuo Nagae together with Scientex chairman Tan Sri Mohd Sheriff Mohd Kassim, managing director Lim Peng Jin, and executive director Choo Seng Hong.

During the event, Lim said the plant inauguration marks an important milestone for Scientex, as it combines Japan’s technological prowess with Scientex’s manufacturing efficiency to produce high quality BOPP film for domestic and regional markets in Asia Pacific.

“We look forward to fulfilling anticipated strong market demand, as Malaysia presently imports most of its BOPP requirements due to a shortage in local supply.

“We also strive to capture new growth opportunities in the regional markets.

“This is certainly a pivotal moment for our consumer packaging business, as we are now one step ahead in realising our target of becoming a leading single-source provider of international-quality consumer packaging films in the region.”

BOPP film forms the protective outer layer of flexible consumer packaging, and is commonly used in the food and beverages industry.

Futamura holds a 10 per cent shareholding in Scientex Great Wall Sdn Bhd (SGW), the Group’s consumer packaging unit, and would purchase approximately one third of the new plant’s annual BOPP film production.

Lim said that the group is actively targeting growth in sales to local and regional players.

“We have been aggressively marketing our high-performance BOPP film to several packaging players both domestically and regionally, and have also conducted product trials with them.

“We are pleased to receive commendable feedback to date, and look forward to commence supply to them in the near term,” Lim concluded.


Aeon Credit an attractive alternative stock to sector

Aeon Credit’ healthy receivable growth and improving asset quality are also key contributors to this growing sentiment focused in a recent company update on Aeoncs by the research arm of Affin Hwang Investment Bank Bhd (Affin Hwang Capital).
Looking at its receivables growth, the research arm expects Aeon Credit to grow at a steady 19 per cent in their financial year 2017 estimates (FY17E), 18 per cent FY18E, and 16 per cent FY19E.
Reasoning for these estimates are based on expectations that Aeoncs’ receivables will be driven by internal factors such as expansion in the personal financing space, further penetration into the high yielding small medium enterprise (SME) segment, the cross-selling of financial products Aeon’s existing customers, and expansion of customer service centres,
Additionally, the signing up of new merchant agreements which would also help drive fee income growth.
For external actors, the research arm has stated that the recent hike in civil servant wages would be an added bonus to Aeoncs receivables as it would boost consumption spending.
“The spill over effect will be on purchases of small ticket items such as electrical goods, electronic and IT gadgets, household furniture as well as increased the affordability to borrow personal loans,” explained the research arm.
In asset quality, Aeon Credit has continued to demonstrate a trend of consistent improvement since its peak in September-November in 2015 at 3.07 per cent.
The research arm affirmed their belief that this positive trend is a result of Aeoncs’s strict and prudent management on credit risk practices and their strong understanding of the consumer financing business.
As such, Affin Hwang Capital has estimated that the trend will continue into FY17 to 19.
“To further enhance its collection system, Aeon Credit has also started self-service kiosks with ATMs, cash-deposit machines and digital devices for its customers in 201,”added the research arm.
Additionally, the overall net credit cost has been slowly decreasing year-on-year and as a result, the research arm has predicted that for 2QFY17 results, “it will not be a surprise to potentially see some slight uptick in the net profit loss (NPL) ratio and credit cost since the quarter coincided with the Raya festival”.
“Based on 1QFY17’s results, the gross NPL ratio was down by five basis points (bps) quarter on quarter to 2.42 per cent, while on a YoY, it declined by 32 bps amidst a healthy growth in receivables  to RM5.8 billion.”
When compared to the banking industry’s household sector gross impaired loan ratios, it should be noted that Aeoncs’ gross net profit loss (NPL) ratio is higher as their portfolio of receivable are in riskier assets and non collateralised.
Despite this, Aeoncs cash flows are compensated by a higher effective interest rate of around 16 to 17 per cent against a borrowing cost of 4.2 per cent.
While there has also been some concern regarding defaults among lower income borrowers in the non-banking financial institutions, the research explains that these issues are mostly triggered by the abundant availability of easy credit with long tenures of up to 25 years.
Additionally, it should  be noted that the trend of easy personal financing schemes back in July 2013, did not affect Aeoncs in a significant way.
“This was due to Aeoncs’ management in-depth understanding of the consumer-financing business, adhering to proper risk management underpinned by tight credit approvals, strict scoring system as well as its prompt collection practices” explained the research arm.
As such, the research arm has opted to maintain their  ‘Buy’ rating for Aeoncs while raising their price targe to RM16.60 from RM14.50.
While the research arm has had strong justification for their positive outlook on Aeoncs, investors should note that he current dizzying household debt  to gross domestic product (GDP) of 89.1 per cent is a key risk to Affin Hwang Capital’s forecast.
“The central bank may undertake further tightening measures to control excessive growth in household debt subsequent to curbs that were imposed in 2013 on personal-loan tenures on all banks and non-banks as well as tighter limits on credit-card spending.

“Should more regulations be imposed, our FY17-19E forecasts could be negatively affected.”




 Earnings still on a growth path: ACSM recorded a NP growth of +10% y-y in FY16 (Feb yr-end), +8% y-y for 1QFY17 and based on street estimates, growth is expected to continue with +6.2% y-y/+7.3% y-y FY17E/FY18E (despite earnings contraction within the banking sector). In my view, there is potentially upside risk to these numbers (volume growth), as ACSM’s target market are more sensitive to interest rate cuts (we expect another 50bps) and fiscal measures targeted for the low-middle income, which we expect in 2H16, i.e. min wage & civil servant wage increases, reduction in EPF contribution, more BR1M payouts. 

 Growth much stronger for underlying receivables growth, versus the 8-10% NP growth and according to management is on track to grow +20% y-y in FY17E, (FY16: +20% y-y; 1QFY17: +21% y-y to RM5.8bn). Motorcycle financing (29.9% of receivables), auto financing (29.5% of receivables) and personal financing (22.4% of receivables) are the three top categories. We do note that there is some conscious slowing down in general easy payment (GEP i.e. white goods financing) and used car financing and a greater emphasis on personal financing and credit cards (~200k cards in circulation). 

 Slowing economy, yet NPLs declined to 2.42% 1QFY17 (from 2.74% in 1Q16), due to ACSM’s prudent risk management policies and in-house expertise and processes having been in the business for over 20 years. Mr Lee believes that borrowers typically will continue repaying as long as they are employed. Classification of NPL happens after 3 months of non-payment, written-off after 6 months of non-payment. Net credit costs also fell to 3.32%, the lowest in 9 quarters. 

 No real competitor as ACSM is sandwiched between money-lenders and banks, with >70% of its c.1mn customer base earning < RM3,000/mth and coupled with the average loan ticket size of RM8,000 and average tenure of 4 years, ACSM is in a segment which does not interest the banks. It’s direct competitors are Bank Rakyat (unlisted) and MBSB (MBS MK, RM0.86, NR) but both have been unsuccessful in migrating from super-safe civil servant salary deduction lending to the “free market” i.e. ACSM makes about 13-15mn calls a year to customers to remind them to pay on time. Parkson Credit, Singer Credit, Wilayah Credit also offer consumer financing and motorcycle financing but we understand are much smaller places in this space. 

 Not as strictly regulated unlike the banks, ACSM only needs to ensure its capital ratio (total equity/receivables) does not fall < 16% as required for all credit card issuers. ACSM is given the freedom to set pricing, with gross yield from 14% for used car financing to as much as 27% for general easy payment. 

 Beneficiary of lower interest rates? ACSM will not immediately benefit from declining interest rates in terms of lowering its funding cost as close to 70% of its funding is fixed-rate (to match its fixed rate lending base) and locked in for 5-6 years from Japanese banks (LT fixed-rate at c.4.28% which is way better than any local bank offers) and the balance (which will benefit from lower interest rates), 30% from local banks (more ST facilities), for an average funding cost of around 4.2%. This is against the overall gross yield for ACSM at ~20%. Lower interest rates should improve demand and a relief for their customers. 

Trading at 8.3-8.7x PER, below market average 15x, with 29% ROE and 4.2-4.6% div yield: Adjusting for RM14.4mn/p.a. distribution paid to perpetual note holders (below net earnings line), ACSM is trading at trading at 8.4-8.7x ann. 1QFY17/FY17E PER or 8.3x FY18E based on consensus estimates, offering a 4.2%/4.6% FY17E/18E dividend yield. ROE were ~35% in FY2014/15 but is lower ~29% in FY16.

24/08/2016 08:19

Sunday, 2 October 2016

Understanding financial statements for non-financial managers and executives (Slide show)

Insurance Accounting

MARCH 2014

Accounting is a system of recording, analyzing and verifying an organization’s financial status. In the United States, all corporate accounting is governed by a common set of accounting rules, known as generally accepted accounting principles, or GAAP, established by the independent Financial Accounting Standards Board (FASB). The Securities and Exchange Commission (SEC) currently requires publicly owned companies to follow these rules. Over time, both organizations intend to align their standards with International Financial Reporting Standards (IFRS).

Accounting rules have evolved over time and for different users. Before the 1930s corporate accounting focused on management and creditors as the end users. Since then GAAP has increasingly addressed investors’ need to be able to evaluate and compare financial performance from one reporting period to the next and among companies. In addition, GAAP has emphasized “transparency,” meaning that accounting rules must be understandable by knowledgeable people, the information included in financial statements must be reliable and companies must fully disclose all relevant and significant information.

Special accounting rules also evolved for industries with a fiduciary responsibility to the public such as banks and insurance companies. To protect insurance company policyholders, states began to monitor solvency. As they did, a special insurance accounting system, known as statutory accounting principles, or SAP, developed. The term statutory accounting denotes the fact that SAP embodies practices required by state law. SAP provides the same type of information about an insurer’s financial performance as GAAP but, since its primary goal is to enhance solvency, it focuses more on the balance sheet than GAAP. GAAP focuses more on the income statement.

Publicly owned U.S. insurance companies, like companies in any other type of business, report to the SEC using GAAP. They report to insurance regulators and the Internal Revenue Service using SAP. Accounting principles and practices outside the U.S. differ from both GAAP and SAP.

In 2001 the International Accounting Standards Board (IASB), an independent international accounting organization based in London, began work on a set of global accounting standards. About the same time, the European Union (EU) started work on Solvency II, a framework directive aimed at streamlining and strengthening solvency requirements across the EU in an effort to create a single market for insurance – see Issues Updates on U.S. Solvency Regulation Solvency II.

Ideally, a set of universal accounting principles would facilitate global capital flows and lower the cost of raising capital. Some 100 countries now require or allow the international standards that the IASB has developed.

Some insurers have been concerned that some of the initially proposed standards for insurance contracts will confuse more than enlighten and introduce a significant level of artificial volatility that could make investing in insurance companies less attractive.


Insurance Contracts: It appears unlikely that the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standard Board (IASB) will be able to achieve a convergence of the two systems with regard to property/casualty insurance. In February 2014 Accounting Today reported that FASB decided to focus on improving U.S. GAAP instead of continuing with the convergence project. For short-duration contracts – which includes most property/casualty insurance – FASB will target changes that enhance disclosures. For long-duration contracts like life insurance, the board concluded it should consider IASB’s approach, though the auditing and consulting firm of Deloitte notes that even in this regard convergence is not the primary objective of the changes.

Financial Reporting: An SEC report published in July 2012 made no recommendations about whether the IFRS should be incorporated into the U.S. financial reporting system although it did say that there was little support among major U.S. corporations for adopting the IFRS as authoritative guidance.


Insurance Basics:

Insurers assume and manage risk in return for a premium. The premium for each policy, or contract, is calculated based in part on historical data aggregated from many similar policies and is paid in advance of the delivery of the service. The actual cost of each policy to the insurer is not known until the end of the policy period (or for some insurance products long after the end of the policy period), when the cost of claims can be calculated with finality.

The insurance industry is divided into two major segments: property/casualty, also known as general insurance or nonlife, particularly outside the United States, and life/health. Broadly speaking, property/casualty policies cover homes, autos and businesses; life/health insurers sell life, long-term care and disability insurance, annuities and health insurance. U.S. insurers submit financial statements to state regulators using statutory accounting principles, but there are significant differences between the accounting practices of property/casualty and life insurers due to the nature of their products. These include:

Contract duration:

Property/casualty insurance policies are usually short-term contracts, six-months to a year. Their final cost will usually be known within a year or so after the policy term begins, except for some types of liability contracts. They are known as short-duration contracts. By contrast, life, disability and long-term care insurance and annuity contracts are typically long-duration contracts — in force for decades.

Variability of Claims Outcomes Per Year:

The range of potential outcomes with property/casualty insurance contracts can vary widely, depending on whether claims are made under the policy, and if so, how much each claim ultimately settles for. The cost of investigating a claim can also vary. In some years, natural disasters such as hurricanes and man-made disasters such as terrorist attacks can produce huge numbers of claims. By contrast, claims against life insurance and annuity contracts are typically amounts stated in the contracts and are therefore more predictable. There are few instances of catastrophic losses in the life insurance industry comparable to those in the property/casualty insurance industry.

Financial Statements: 

An insurance company’s annual financial statement is a lengthy and detailed document that shows all aspects of its business. In statutory accounting, the initial section includes a balance sheet, an income statement and a section known as the Capital and Surplus Account, which sets out the major components of policyholders’ surplus and changes in the account during the year. As with GAAP accounting, the balance sheet presents a picture of a company’s financial position at one moment in time—its assets and its liabilities—and the income statement provides a record of the company’s operating results from the previous period. An insurance company’s policyholders’ surplus—its assets minus its liabilities—serves as the company’s financial cushion against catastrophic losses and as a way to fund expansion. Regulators require insurers to have sufficient surplus to support the policies they issue. The greater the risks assumed, and hence the greater the potential for claims against the policy, the higher the amount of policyholders’ surplus required.

Asset Valuation: 

Property/casualty companies need to be able to pay predictable claims promptly and also to raise cash quickly to pay for a large number of claims in case of a hurricane or other disaster. Therefore, most of their assets are high quality, income-paying government and corporate bonds that are generally held to maturity. Under SAP, they are valued at amortized cost rather than their current market cost. This produces a relatively stable bond asset value from year to year (and reflects the expected use of the asset.)

However, when prevailing interest rates are higher than bonds’ coupon rates, amortized cost overstates asset value, producing a higher value than one based on the market. (Under the amortized cost method, the difference between the cost of a bond at the date of purchase and its face value at maturity is accounted for on the balance sheet by gradually changing the bond’s value. This entails increasing its value from the purchase price when the bond was bought at a discount and decreasing it when the bond was bought at a premium.) Under GAAP, bonds may be valued at market price or recorded at amortized cost, depending on whether the insurer plans to hold them to maturity (amortized cost) or make them available for sale or active trading (market value).

The second largest asset category for property/casualty companies, preferred and common stocks, is valued at market price. Life insurance companies generally hold a small percentage of their assets in preferred or common stock.

Some assets are “nonadmitted” under SAP and therefore assigned a zero value but are included under GAAP. Examples are premiums overdue by 90 days and office furniture. Real estate and mortgages make up a small fraction of a property/casualty company’s assets because they are relatively illiquid. Life insurance companies, whose liabilities are longer term commitments, have a greater portion of their investments in commercial mortgages.

The last major asset category is reinsurance recoverables. These are amounts due from the company’s reinsurers. (Reinsurers are insurance companies that insure other insurance companies, thus sharing the risk of loss.) Amounts due from reinsurance companies are categorized according to whether they are overdue and, if so, by how many days. Those recoverables deemed uncollectible are reported as a surplus penalty on the liability side of the balance sheet, thus reducing surplus.

Liabilities and Reserves: 

Liabilities, or claims against assets, are divided into two components: reserves for obligations to policyholders and claims by other creditors. Reserves for an insurer’s obligations to its policyholders are by far the largest liability. Property/casualty insurers have three types of reserve funds: unearned premium reserves, or pre-claims liability; loss and loss adjustment reserves, or post claims liability; and other.

Unearned premiums are the portion of the premium that corresponds to the unexpired part of the policy period. Premiums have not been fully “earned” by the insurance company until the policy expires. In theory, the unearned premium reserve represents the amount that the company would owe all its policyholders for coverage not yet provided if one day the company suddenly went out of business. If a policy is canceled before it expires, part of the original premium payment must be returned to the policyholder.

Loss reserves are obligations that an insurance company has incurred – from claims that have been or will be filed on the exposures the insurer protected. Loss adjustment reserves are funds set aside to pay for claims adjusters, legal assistance, investigators and other expenses associated with settling claims. Property/casualty insurers set up claim reserves only for accidents and other events that have happened.

Some claims, like fire losses, are easily estimated and quickly settled. But others, such as products liability and some workers compensation claims, may be settled long after the policy has expired. The most difficult to assess are loss reserves for events that have already happened but have not been reported to the insurance company, known as "incurred but not reported" (IBNR). Examples of IBNR losses are cases where workers inhaled asbestos fibers but did not file a claim until their illness was diagnosed 20 or 30 years later. Actuarial estimates of the amounts that will be paid on outstanding claims must be made so that profit on the business can be calculated. Insurers estimate claims costs, including IBNR claims, based on their experience. Reserves are adjusted, with a corresponding impact on earnings, in subsequent years as each case develops and more details become known.

Revenues, Expenses and Profits:

Profits arise from insurance company operations (underwriting results) and investment results.

Policyholder premiums are an insurer’s main revenue source. Under SAP, when a property/casualty policy is issued, the pre-claim liability or unearned premium is equal to the written premium. (Written premiums are the premiums charged for coverage under policies written regardless of whether they have been collected or “earned.” Each day the policy remains in force, one day of unearned premium is earned, and the unearned premium falls by the amount earned. For example, if a customer pays $365 for a one-year policy starting January 1, the initial unearned premium reserve would be $365, and the earned premium would be $0. After one day, the unearned premium reserve would be $364, and the earned premium would be $1.

Under GAAP, policy acquisition expenses, such as agent commissions, are deferred on a pro-rata basis in line with GAAP’s matching principle. This principle states that in determining income for a given period, expenses must be matched to revenues. As a result, under GAAP (and assuming losses and other expenses are experienced as contemplated in the rate applied to calculate the premium) profit is generated steadily throughout the duration of the contract. In contrast, under SAP, expenses and revenues are deliberately mismatched. Expenses associated with the acquisition of the policy are charged in full as soon as the policy is issued but premiums are earned throughout the policy period.

SAP mismatches the timing of revenues and acquisition expenses so the balance sheet is viewed more conservatively. By recognizing acquisition expenses before the income generated by them is earned, SAP forces an insurance company to finance those expenses from its policyholders’ surplus. This appears to reduce the surplus available to pay unexpected claims. In effect, this accounting treatment requires an insurer to have a larger safety margin to be able to fulfill its obligation to policyholders.

The IASB Proposal for International Insurance Accounting Standards: IASB’s aim in establishing accounting standards for the insurance industry is to facilitate the understanding of insurers’ financial statements. Insurance contracts had been excluded from the scope of international financial reporting standards, in part because accounting practices for insurance often differ substantially from those in other sectors — both non-insurance financial services and nonfinancial businesses, and from country to country.


Reading and Analyzing Insurance Ratios.

Financial institutions such as banks, financial service companies, insurance companies, securities firms and credit unions have very different ways of reporting financial information.

This guide gives you the most pertinent information to analyze an insurance company's financial statements.

Underwriting Ratios

Loss Ratio

USBR calculates the loss ratio by dividing loss adjustments expenses by premiums earned.

The loss ratio shows what percentage of payouts are being settled with recipients.

The lower the loss ratio the better.

Higher loss ratios may indicate that an insurance company may need better risk management policies to guard against future possible insurance payouts.

Loss Ratio = ( Loss Adjustments / Premiums Earned )

Expense Ratio

USBR calculates the expense ratio of an insurance company by dividing underwriting expenses by net premiums earned.

Underwriting expenses are the costs of obtaining new policies from insurance carriers.

The lower the expense ratio the better because it means more profits to the insurance company.

Expense Ratio = ( Underwriting Expenses / Net Premiums Written )

Combined Ratio

This figure just measures claims losses and operating expenses against premiums earned.

The lower the figure the better.

The combined ratio is the total of estimated claims expenses for a period plus overhead expressed as a percentage of earned premiums.

A ratio below 100 percent represents a measure of profitability and the efficiency of an insurance firms underwriting efficiency.

Ratios above 100 percent denote a failure to earn sufficient premiums to cover expected claims.

High ratios can usually occur either because of underpricing and/or because of unexpected high claims.

Combined Ratio = ( Loss Ratio + Expense Ratio )

Ratio of Net Written Premiums to Policyholder Surplus

This ratio measures the level of capital surplus necessary to write premiums.

An insurance company must have an asset heavy balance sheet to pay out claims.

Industry statuary surplus is the amount by which assets exceed liabilities.

For instance: a ratio 0.95 -to 1 means that insurers are writing less than $1.00 worth of premium for every $1.00 of surplus. A ratio of 1.02-to-1 means insures are writing about $1.02 for every $1.00 in premiums.

Profitability Ratios

Return on Revenues

This figure determines the profitability of an insurance company .

It is the profits after all expenses and taxes are paid by the insurance company.

Return on Revenues = ( Net Operating Income / Total Revenues )

Return on Assets

USBR calculates the return on assets by dividing net operating income by Mean average assets.

This figure shows the profitability on existing investment securities and premiums.

The higher the return on assets the better the company is enhancing its returns on existing liquid assets.

Return on Assets ( Net Operating Income / Mean Average Assets )

Return on Equity

This figure shows the net profits that are returned to shareholders.

The higher the return on equity, the more profitable the company has become and the possibility of enhanced dividends to shareholders.

Return on Equity = ( Net Operating Income (less preferred stock Dividends / Average Common Equity )

Investment Yield

This is the return received on an insurance company's assets.

The investment yield is obtained by dividing the average investment assets into the net investment income before income taxes.

Investment Yield = ( Average investment Assets / Net Investment Income )



Understanding An Insurance Company's Revenue Model

The revenue models of insurance companies are based on premiums collected from policyholders.

Premiums are the starting point for revenues earned by all types of.

This includes

  • life insurance companies, 
  • auto insurance companies, 
  • companies that sell homeowner’s insurance and 
  • even companies that sell annuities.

Pricing of Risk by an Insurance Company

The revenue model starts with the pricing of risk and the sale of an insurance policy. 

The insurance policy’s benefit amount represents the amount that the insurance company is willing to pay should a loss occur. 

For life insurance, that loss is death.

With property and casualty insurance such as auto and homeowner’s insurance, the loss is damage, theft or destruction of property, such as a home or auto.

Risk Pooling and Premium Pricing

The willingness to accept this risk comes at a price to the policy owner.

This price is the premium amount and is based on the common occurrence of risk, as distributed among a large class of people.

This process is known as risk pooling and is performed by actuaries hired by the insurance company.

The risk pools determine the likelihood of a loss occurring for a class and the price for that risk, which becomes the premium amount.

Net Premiums

When the premium is paid, the insurance company nets out its expenses associated with keeping the coverage in force.

This includes commissions paid to agents and brokers of the insurance company.

It also includes the administrative and operational costs of the insurer such as overhead, salaries and other business related expenses.

The net amount of the premium represents the revenue amount that the insurer has to invest.

General Account versus Separate Account Assets

For life insurance companies, 2 accounts are maintained in order to address the risks associated with their products.

These accounts are the general account and separate account of the insurance company.

 In the general account, net premiums from fixed products issued by the life insurance company such as fixed annuities, term life, whole life and universal life products are deposited.

 These net premiums are invested in fixed income securities such as municipal and treasury bonds in order to back the insurer’s promise to pay.

Separate Account

The separate account is backed with net premiums from variable insurance products such as variable annuities and variable life insurance.

These product’s premiums must be segregated or maintained in a separate account by law since it is the policy owner that determines how the premiums are invested, not the insurer. 

This investment control means that the policy owner is subject to a greater risk because those premiums are in the stock market and other equity securities.

Interest Earnings and Revenue

The interest earned by the investment of assets in either the general account for life insurance and property and casualty insurance companies or separate account for the life insurer is a component of overall revenue for the insurer. 

Savings realized by lowered expenses and less than expected risk losses (i.e. deaths, illness, disability, auto accidents) leads to higher revenues for an insurance company.

Read more: http://www.finweb.com/insurance/understanding-an-insurance-companys-revenue-model.html#ixzz4LuUiuIiJ


Understanding an Insurer's Balance Sheet

Understanding an Insurer's Balance Sheet

Insurance companies are magical creatures that, in the hands of a skilled operator, perform alchemistic feats and literally mint money. However, reading and understanding their financial statements are a little difficult, so let's try to break this task down into bite-sized chunks. First we'll get familiar with the terms and calculations; later on, we'll see how the statements are linked and flow into each other.
Balancing Sheet ActInsurance companies are balance-sheet-driven businesses, so we'll start here with the assets. Let's look at the 2005 balance sheet assets of two auto insurers, Progressive(NYSE: PGR  ) and Mercury General (NYSE: MCY  ) .
2005 Assets (Millions of Dollars)
Fixed Maturity Securities
Preferred Stock
Common Equities
Short-Term Investments
Accrued Investment Income
Premiums Receivable
Premium Notes
Reinsurance Recoverable
Prepaid Reinsurance Premium
Deferred Acquisition Cost
Income Taxes
Property and Equipment
Other Assets
Total Assets

This is way too complicated, so let's make some simplifications. 
1.   We'll group all investments (bonds, stocks) into "investments" and throw cash in there as well. 
2.   Then we'll make a category called "policyholder money we don't have yet." This refers to:
  • future premiums to be received (premiums receivable)
  • money that the reinsurers owe (reinsurance recoverable)
  • money already paid to reinsurers for future reinsurance policies (prepaid reinsurance premium)
  • money already paid -- but not expensed yet -- such as agent commissions and premium taxes, to acquire policies (deferred acquisition cost).
3.   Everything else we'll call "other assets." (PLEASE -- when investing in an insurer, read the footnotes -- I'm simplifying here for clarification purposes)

Our simplified balance sheet reads:
Policyholder Money We Don't Have Yet
Other Assets
Total Assets

Now that you've got the hang of how I'm simplifying things, we'll reduce liabilities and shareholder's equity. 

1.   First, we see "policyholder money we have" -- made up of:
  • unearned premiums (policyholder money paid for future coverage)
  • loss and loss adjustment expense (policyholder money set aside for already incurred losses, incurred but not reported losses, and the cost of settling claims)
  • other policyholder liabilities
2.   We also have "debt," which is made up of -- you guessed it -- debt.
3.   "Other liabilities," made up of items such as accounts payable and accrued expenses. 
4.   Finally, there is shareholder's equity (assets minus liabilities, similar to liquidation value). 

Our simplified balance sheet looks like this (to make this even more readable, I am reformatting numbers in billions):
Simplified 2005 Balance Sheet (Billions of dollars)
Policyholder Money We Don't Have Yet
Other Assets
Total Assets

Liabilities & Equity
Policyholder Money We Have
Other Liabilities
Shareholders' Equity
Total Liabilities + Equity

The first thing to note here is float. In a nutshell, float refers to the money that policyholders give to insurers in return for insurance. With our simplified balance sheet, calculating float is simple:
Float = Policyholder money we have - Policyholder money we don't have yet
In this case, we can see Progressive has about $6.5 billion in float, and Mercury has roughly $1.5 billion. We can also see "Other Assets" and "Other Liabilities" are about equal, so we'll net and ignore these. Lastly, we have debt and shareholder's equity value.
Thus, we have three main pieces that comprise the balance sheet (ignoring other assets and liabilities, which we've netted out): 
  • float, 
  • debt, and 
  • shareholder's equity.

The reason I simplified to these three points is because each of these represents the different pieces of financing: 
  • float is money provided by policyholders, 
  • debt is provided by creditors, and 
  • shareholder's equity (estimated liquidation value) is provided by equity holders.

Back to basics

An insurer takes money from these three sources of funding (policyholders, creditors, and stock holders) and invests it. If we take Progressive's float ($6.5 billion), debt ($1.3 billion), and shareholder's equity ($6.1 billion) we get $13.9 billion -- notice this is about equal to Progressive's $14.3 billion in investments. In other words, an insurer takes money from policyholders (float) and creditors (debt), and pays out operating expenses, claims and claims expenses, and interest payments. The remainder is left over for the stock holders and taxes -- this money is reinvested into investments and increases shareholder's equity, which increases the value of the insurance company to stock holders. However, if the insurer is taking bad risks it'll end up owing a lot of claims (if the losses fall to the bottom line, this eats into shareholder's equity) -- the money to pay out claims comes out of float and investments, which is bad.
By now it should be clear what drives an insurer's balance sheet value: the more shareholder's equity and float, the better. (Quick note: In the short run, if an insurer under-prices its policies it can grow premiums and float very quickly; in the long run losses will eat up the float and shareholder's equity. Watch out for the fools that rush in.) Progressive's $6.5 billion in float (at the end of 2005) and $6.1 in estimated liquidation value were valued at $21 billion. Mercury General's $1.5 billion in float and $1.6 billion in liquidation value were valued at $3.2 billion at the end of 2005.
Hopefully this provides a simplistic and clear understanding of the different pieces of an insurer's balance sheet. Later on we'll look at the other financial statements and link them together to see how an insurer creates or destroys shareholder value.
For some other insurance commentary, check out:
Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above and appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.