NRMA less than it appears
There is a temptation, given the massive profile the company has through its roadside service to motorists, to forget that we are actually dealing with an insurance company and it must be judged by insurance company standards – household name or not (although being a biggy, it will benefit from the need for index funds to include it in their portfolios).
It also must be judged by the standards of its management, which, while professional enough, has been distinguished more for the vicious in-fighting in the run-up to the float than for its innovative industry-leading judgment. More of that later, but first a look at NRMA's operational record.
Competitive industry
The road service people may be knights of the road, but in reality NRMA's core business, general insurance, is pretty ordinary. In recent times, the industry in Australia has been an increasingly competitive one, marked by a high level of claims and underwriting losses relative to premiums received. In that kind of environment, Ernst and Young, in their independent expert's report prepared at the time members voted to take NRMA public, estimated that NRMA's insurance business had enjoyed a return on equity in the 1994-1999 period of around 8.3% - unacceptable in most other industries. While the position is improving, it had only reached 12.5% in 1998/99.
But of course the question really is how this should be reflected in the share price.
Now, valuation is an art rather than a science and, by some measures, NRMA's present price is acceptable. We, however, do not think that factors in a satisfactory margin of safety. Ernst and Young looked at comparable general insurance companies around the world and decided that if measured by compared PERs or multiples of net assets NRMA could be worth more than it is now - $4.77bn and $5.1bn respectively – a PER of 16. Note that this is the high end of the valuation – in other words, the maximum allowable level of optimism. It also requires a degree of caution because of when the valuation was made, given the high PERs generally in the world's major stock markets.
Cautious note
Ever cautious, we prefer a more conservative valuation, and do this using a multiple of the insurance profit (that is, leaving aside whether NRMA's investment professionals are hot shots or not) and NRMA is worth $4.2bn at most - and that's after allowing a generous multiple of 18. On this second way of looking at things, the present market capitalisation of $4.5bn doesn't leave much in it for shareholders.
And then there's the management. The bruising fight to get the NRMA to market may have been a triumph for Nick Whitlam – a man with all the arrogance of his father and little of his charm – but it has left a bad taste in many mouths. That will be settled one way or another (no doubt by a night or two of the long knives). Let's hope for everyone's sake that this is done as quickly and as painlessly as possible and that eyes are not taken from the difficult ball in play for an insurer in a rising interest rate environment.
All of these factors, combined with stockmarket volatility, which will inevitably hit investment returns - or at the very least create uncertainty, leads to the overriding question you should ask yourself: are you as optimistic as the high numbers used above suggest you should be? If not, then you would agree with us that NRMA is a HOLD.