Charles Taylor PLC (CTR:LSE)

Charles Taylor offers a range of management and professional services to the global insurance market; in addition, it also owns a small life insurance business. The company derives most of its revenues from its professional services businesses (~97%) which operate on a fee-based model, with the rest coming from its owned life insurance business.

This is an attractive business – it has a strong and durable moat; it has been in existence since 1884 and has developed deep connections with its client base in the global insurance market; its services are an essential part of its client's business, very technical and bespoke in nature and delivered by a highly skilled and varied workforce; it is very difficult to switch providers for these services; the company has a solid management team; and its financials look - with a strong balance sheet and a track record of revenue, EBITDA, and earnings growth. Moreover, I believe that the business is headed in the right direction at present.

At 11.4 times my forecast FY17 EPS, and with good growth prospects, I believe the stock offers good value. I calculate intrinsic value per share in the range of £3.35 - £3.65, which implies a 22% - 33% upside to the current share price of £2.745. The stock also offers a decent dividend yield of 4% based on my forecast for FY17.

Overview of the business & investment case

Charles Taylor’s professional services businesses operate through three main divisions:

·         Management Services provides end-to-end management for insurance companies covering every aspect of an insurance business from management of underwriting claims to regulatory and accounting services. The division has a solid client list consisting of – The Standard Club, which provides liability insurance to 10% of world shipping; Signal Mutual, the largest provider of Longshore workers’ compensation insurance in the US maritime industry; SCALA, which provides workers’ compensation to the majority of Canada’s ship owners; and it also provides administration services to The Offshore Pollution Liability Association (OPOL), a mutual insurance association established to meet offshore pollution claims under the Offshore Pollution Liability Agreement 1974. The division has been a solid performer contributing ~35% of the group’s revenues, and ~55% of group’s EBITDA. It is highly cash generative, reliable, and has shown decent growth (FY15 EBITDA of £10.3m with a ~7% EBITDA growth over the last 5 years).

·         Adjusting Services provides loss adjusting services across the aviation, energy, marine, property & casualty and special risks sectors. The division specialises in resolution of larger and more complex losses arising from major incidents. This is a cyclical business which does well at times of natural catastrophes and man-made disasters, when insured losses are high and specialist adjusting services are in demand. Based on stats, this has not been the case over the last few years, with insured losses running 30% - 40% below their 10 year average. The positive sign here is the fact that the company has grown revenues at over 4% in the last 5 years and has invested in opening new offices in new geographies, and recruited senior loss adjusters. The investment has meant that EBITDA has remained flat at ~£3.5m over the last two years. However, given the resilience shown by the division during a benign claims environment, and the investment the company has made in growing the business, the future looks good as and when the claims environment picks up.

·         Insurance Support Services business provides a range of professional and technology services wherein insurance clients can select specific stand-alone services of their choice, including - outsourced insurance support services, technology services, investment management, captive management and specialty risk management. Management also view this division as the Group’s business incubator where they can develop and test new business initiatives. Financially, this division has been a growth story, with sales growth of ~48% over the last four years, and EBITDA growth of ~60% in the same period. FY15 EBITDA stood at £5.15m. I see continued growth prospect for this business line, and particularly like the technology offering and turn-key managing agency offering. And given the deep relationships with clients across other business divisions, there is tremendous scope for cross selling .

·         Recent acquisitions add value to the business. Charles Taylor raised ~£30m through a rights issue in March 2015, following which it has made two significant acquisitions which I believe add good value to its professional services offerings. In July 2016 it acquired CEGA, a specialist provider of technical medical assistance and travel claims management services with over a 40 year track record and good growth. CEGA had FY15 revenues of £31m (equates to ~22% of Charles Taylor’s FY15 revenues of £138.6m from its professional services divisions) and FY15 EBITDA of £3.3m (equates ~17% of Charles Taylor’s FY15 EBITDA from its professional services divisions). According to management presentation, CEGA’s EBITDA has grown at 7.5% over the last previous two years. The acquisition has a maximum consideration of £29.8m, with £23.8m paid upfront & £6m deferred and payable subject to future performance hurdles being met. Assuming full deferred consideration is paid, the price equates to 8x CEGA’s FY15 EBITDA, which appears fair given growth prospects. The other significant acquisition was a 25% investment in Fadata, a specialist software solutions provider to insurance businesses for a consideration of £3.7m. Both acquisitions are a good fit; CEGA should contribute meaningfully to revenues and EBITDA from FY17 onwards in addition to providing a new, technical, high value-add professional service business line which is closely-related to Charles Taylor’s existing core businesses; and the Fatada stake is already being exploited by the company - business plans to be an implementation partner of Fadata, and is already undertaking joint marketing initiatives with Fadata, which it anticipates will lead to projects to implement its end-to-end policy administration system

In sum, Charles Taylor’s professional services divisions enjoy a strong moat across business lines, and offer tremendous ability to cross sell within its sphere of its competitive advantage – e.g. the ability to develop and sell bespoke insurance technology services given its knowledge and experience of the insurance markets. This reminds me of what Pat Dorsey, author of The Little Book that Builds Wealth states: “The way I think about the linkage between moats (competitive advantages) and intrinsic value is that moats add the most value to businesses that have lots of reinvestment opportunities within their moats. A business that has a large set of investment opportunities “inside the moat” has a much higher intrinsic value than a business without competitively advantaged reinvestment opportunities because the former compounds cash flow at a very high rate, whereas the latter is forced to use cash for sub-optimal opportunities.”

·        Finally, there is the owned insurance companies business which are primarily in run-off (i.e., an insurance policy provision that provides liability coverage against claims made against companies that have been acquired, merged, or have ceased operations and indemnifies the acquiring company from lawsuits against the directors and officers of the acquired company). Here, the group aims to deliver value through operational efficiencies. The division contributes ~3% of the group revenues, and EBITDA and has a net book/equity value of £11.8m as at FY15.

Valuation

I forecast FY17 earnings from operations of £16.12m, or £0.24 earnings per share (EPS); this equates to Forecast FY17 P/E of just 11.45. And based on FY15’s adjusted EPS of £0.1998, the company currently trades at P/E of 13.75. Even assuming the company continues to trade at the 13.75 P/E multiple, this would equate to value per share of £3.3 based on my FY17 forecast EPS, implying a 20% return to the current share price of £2.745. However, given the growth prospect, low downside risk and the resilience of the business, I believe that the stock merits at least a P/E multiple of 15, equating to value per share of £3.6 based on my FY17 forecast EPS, and implies a 31% return to current share price.

I have cross checked my P/E multiple with a DCF valuation. My DCF valuation gives me a value per share of £3.63, implying a 32% return to current share price which is consistent with my 15x P/E multiple. I have made the following assumptions for my DCF:

-         EBITDA growth of 2% for the professional services businesses (which is conservative given recent growth and prospects for future); WACC of 7%;  ROIC of 8% (which has been the average over last 4 years); and an effective tax rate of 15% (last 5 year effective tax rate has average 12%).

-         Note that I have valued the insurance business at its FY15 book value of £11.8m which I think is conservative.

The result of my DCF valuation is shown below.

*Liabilities attributable include - pensions obligations (£40m), deferred consideration (£9.6m), debt (£22m), non-controlling interest (£2.1m), projected cash & equivalents after allowing for CEGA consideration and cash attributable to insurance business (£30m). 

In summary, I believe that Charles Taylor is a great business priced attractively and offers an attractive good return prospect with limited downside risks.