Exiting Unprofitable Auto Business And Broker Platform Expansion Will Strengthen Position In Canada's Insurance Market

Key Takeaways

• Strategic broker platform investment and organic growth are set to enhance revenue through increased premiums, supporting earnings growth.
  
• Improved profitability through exit from loss-making operations and operational efficiency will drive higher operating ROE and earnings growth.
  
• Exiting an unprofitable auto business might hurt revenue, while cost pressures, competition, and strategic changes could challenge growth and margins across segments.

Catalysts

Offers property and casualty insurance products in Canada.

• Definity's strategic growth of its broker platform, with over $800 million invested, has positioned it as the tenth largest P&C insurance broker in Canada. Continued M&A activity and expected organic growth should enhance revenue through increased premiums and contribute to earnings growth.
  
• Exiting the loss-making Sonnet Alberta personal auto business should improve overall profitability, allowing the company to maintain a strong combined ratio and improve net margins by eliminating negative drag on profitability from prior quarters.
  
• The company anticipates favorable market conditions in personal property, coupled with proactive underwriting and rate actions, to drive high single-digit premium growth in 2025. This should contribute to revenue growth and support improved combined ratios, enhancing earnings.
  
• Commercial lines are expected to maintain a robust growth trajectory at approximately twice the industry rate, supported by a comprehensive value proposition and advanced underwriting capabilities. This growth should bolster revenue and profitability despite competitive pressures in some segments.
  
• Definity's ongoing focus on improving operational efficiency, particularly in reducing the operating expense ratio, alongside disciplined pricing strategies and low claim ratios, positions the company to drive operating ROE higher and deliver attractive earnings growth.

Definity Financial Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Definity Financial's revenue will grow by 7.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 10.0% today to 8.6% in 3 years time.
• Analysts expect earnings to reach CA$464.0 million (and earnings per share of CA$3.98) by about March 2028, up from CA$430.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 17.9x on those 2028 earnings, up from 15.7x today. This future PE is greater than the current PE for the CA Insurance industry at 13.3x.
• Analysts expect the number of shares outstanding to decline by 0.95% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.82%, as per the Simply Wall St company report.

Definity Financial Future Earnings Per Share Growth

Risks

• The exit from Sonnet Alberta personal auto business, despite being previously unprofitable, may still negatively impact top-line growth in auto premiums, creating potential variability in overall revenue.
  
• The anticipation of continued cost pressures, regulatory challenges in Alberta, and uncertainty concerning potential U.S. tariffs could impact the auto insurance segment, affecting net margins.
  
• Competitive pressures in some commercial segments, despite an overall attractive market, could compress margins or hinder growth in underwriting profitability.
  
• The strategic changes to the reinsurance program, including higher attachment points, might expose the company to greater losses in the event of high-severity catastrophes, impacting net earnings negatively.
  
• The dependence on achieving organic growth and successful M&A activity to hit financial targets could pose execution risks, potentially affecting anticipated revenue and earnings growth.

Valuation

• The analysts have a consensus price target of CA$63.667 for Definity Financial based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$71.0, and the most bearish reporting a price target of just CA$61.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be CA$5.4 billion, earnings will come to CA$464.0 million, and it would be trading on a PE ratio of 17.9x, assuming you use a discount rate of 5.8%.
• Given the current share price of CA$59.25, the analyst price target of CA$63.67 is 6.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.