Regulatory scrutiny on undervalued ASX shares

Narrow Moat Rated Steadfast's SDF, and to a lesser extent, Narrow Moat Rated AUB Group's AUB, shares fell materially following an ABC report concerning strata insurance commissions. The crux of the allegations being that Steadfast brokers are conflicted in recommending strata insurance because Steadfast owns the largest strata agency in the country, CHU. And as a result, premiums are rising for customers because of Steadfast’s market dominance. Another claim, which Steadfast did not dispute, is the existence of joint ventures between brokers and strata managers that potentially skirt the strata managers' disclosure requirement as it is not “commission.”

This is a bad look, adding an unnecessary financial incentive to use one broker over another. Considering all this, the chair of Australia’s competition regulator is calling for a ban on strata insurance commissions. Nevertheless, we think both narrow-moat firms are undervalued, with the potential regulatory intervention in the sector rattling confidence.

Steadfast equity-owned strata insurance brokers contributed around 5% of fiscal 2024 group profit. The agency business is much more heavily weighted to strata, though—we estimate the total contribution to profit from strata is between 15% and 20%. AUB has a smaller exposure to strata, making up 5% of gross written premium, or GWP, in fiscal 2024.

We lower our Steadfast fair value estimate by 8% to $6 per share and AUB Group's by 3% to $34 per share on downward revisions to agency earnings. For Steadfast we assume some market share loss and downward pressure on premium rates in strata. Increased oversight on brokers to ensure all policies are in the client’s best interests, even if it becomes overly cautious, could see more volume go to other insurers. CHU may be forced to compete more on price, even if a competing policy is not entirely comparable, to reduce the risk of customers feeling they are being given dud advice.

AUB business strategy and outlook

AUB Group operates the second-largest general insurance broker network in Australia and New Zealand. AUB brokers derive revenue from commissions paid by insurers, based on gross written premiums. AUB owns or has equity stakes in each broking business within the network. Around half of group profit is delivered by the Australian and New Zealand broker network, around 30% from Tysers in the United Kingdom, and the remainder from underwriting agencies.

A key value proposition over smaller brokers is AUB’s ability to negotiate more favorable policy wording and pricing. Scale also provides the capacity to spend more on technology, which helps facilitate greater analytical and processing capabilities, and marketing to help attract and retain customers. Other services such as claims support and premium funding support the value proposition.

AUB Group’s underwriting agencies distribute insurance products but take no underwriting risk. Underwriting agencies act on behalf of insurers to design, develop, and provide specialized insurance products and services.

The earnings outlook is positive. We expect further insurance price rises over the medium term, albeit not at double-digit levels recently experienced, as insurers seek to cover claims inflation and higher reinsurance costs.

We expect insurance brokers to take share of the intermediated market. Technology should allow a greater number of policies per client—for example, adding personal motor/home on top of a business client's insurance needs. AUB’s investment in BizCover, a self-service insurance platform targeting small SMEs, and partnership with accounting firm Kelly+Partners to act as a lead generator should see AUB take share of the small SME end of the market. This share will most likely come from the direct channel.

The acquisition of Tysers was material for AUB Group. We are optimistic that cost and revenue synergy benefits, as well as insurers lifting prices, will lead to solid earnings growth for the business.

Steadfast’s business strategy and outlook

Steadfast Group operates the largest general insurance broker network in Australia and New Zealand. Taking equity interests in insurance broker business, Steadfast has been consolidating the market since it was founded in 1996. It has deployed a similar strategy in underwriting agencies. It derives revenue by being paid a commission (from insurers) based on gross written premium written by agencies within its network, earning a share of profits from associates and joint ventures, and receiving professional services fees.

A key value proposition of Steadfast’s is its superior technology over smaller brokers, which helps facilitate greater analytical and processing capabilities. The ability to offer improved policy wordings, access to technology and triage support for claims helps entrench Steadfast’s appeal.

Steadfast's fast-growing underwriting agencies distribute insurance products through both the Steadfast network and other networks and brokers. Underwriting agencies act on behalf of insurers to design, develop, and provide specialized insurance products and services. The underwriting agencies do not take on underwriting risk.

The earnings outlook is positive. We expect further insurance price rises over the medium term as insurers seek to cover claims inflation. There is also potential upside if usage of the Steadfast Client Trading Platform gains traction. Insurance transactions via SCTP generate higher broker commissions, financially benefiting the brokers and Steadfast itself. We believe this increases the appeal of the Steadfast network, helping to strengthen its switching costs and potentially gain more scale. Acquisitions are also likely to remain a feature of the group's growth, both in Australia and the US.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.