NN Group Offers A Good Combination Of Income And Value (OTCMKTS:NNGPF)

NN Group (OTCPK:NNGPF) (OTCPK:NNGRY) is currently offering a high-dividend yield that is sustainable over the long term and has a discounted valuation in the European insurance sector.

As I’ve covered in a previous article, I see NN Group as a good income pick in the European insurance sector, due to a high-dividend yield and attractive valuation.

Since then, its shares are up by more than 25%, including dividends, thus after a strong share price rally I think it’s now a good time to revisit its investment case, to see if it remains an attractive income option or not in the European insurance sector.

Business Overview

Nationale Nerderlanden (NN Group) is a Dutch insurance company, offering life and non-life insurance to its customers, plus some banking products. It’s present in several European countries and Japan, even though its domestic market continues to be its largest one. Its shares are traded in the U.S. on the over-the-counter market, and its current market value is about $14 billion.

The company operates in eleven countries and has about 19 million customers, operating under a multi-brand approach. NN Group was also active in asset management, but sold this business segment to Goldman Sachs (GS) in 2022, for about €1.7 billion.

Following this asset sale, NN Group’s business become more concentrated in its domestic insurance operations, which were responsible for about 69% of its organic capital generation in the past year, followed by insurance in other European countries, while Japan and banking have much smaller contributions.

This shows that its core business is Life insurance, while it also offers complementary products in non-life, plus banking products (mainly mortgages and savings). Due to this business geared to the Life segment, NN Group’s closest peers are other European insurance companies with significant operations in the life segment, such as AXA SA (OTCQX:AXAHY), ageas (OTCPK:AGESY), or ASR Nederland (OTCPK:ARNNY).

In the Dutch life insurance market, it has a leading position, with a market share of about 40% in pensions, while in the non-life segment is the second-largest company, with a market share of about 27%. In the Netherlands, it has bancassurance partnerships with four of the top five banks in the country, with Rabobank being the only exception. In other European countries, it has top three positions in several countries, but generally speaking, it’s not a leading company.

Due to its strong market presence in the Netherlands and insurance being a mature industry in Europe and Japan, NN Group’s long-term growth prospects are relatively muted. Indeed, one of its key operating metrics is operating capital generation (OCG), which amounted to €1.9 billion in 2023, which is already in-line with its new goal by 2025 (recently revised from €1.8 billion). Over the long term, its ambition is to grow OCG by mid-single digit, showing that its business growth over the coming years is expected to be relatively low.

This means its growth strategy is expected to remain essentially focused on organic growth initiatives, aiming to improve its efficiency and profitability over the next few years, but its business profile is not expected to change much compared to its current profile in the near future.

Financial Overview

Regarding its financial performance, NN Group has reported relatively positive results last year, given that insurance income increased by 1.8% YoY to nearly €10.5 billion, and its operating result improved to more than €2.5 billion in 2023. Adjusted for the sale of NN Group’s asset management business, its operating result increased by 7.6% YoY.

This improvement was supported mainly by its European insurance and banking operations, while its domestic segment (both life and non-life) reported slightly lower operating results in the past year. In the life segment, this was justified by lower risk adjustment releases and in the non-life segment due to higher claims costs on the disability business line. Its net result from continuing operations was nearly €1.2 billion, almost the double from the previous year, when adjusted for the sale of NN Investment Partners and other one-off effects.

Investors should note that NN Group booked in the last quarter of 2023 a provision of €362 million related to the unit-link litigation issue, in which customers were complaining about some cost deductions and a Dutch court ruled contrary to NN.

The company was able to reach a settlement with interest groups back in January, leading to a €300 million provision, while customers who were not part of interest groups represent a small part of potential litigation and the company decided to make a further €60 million provision to cover these cases. NN considers residual risk to be not material taken into account its measures taken to compensate policyholders over time; thus further costs related to this issue aren’t likely in the future.

Another positive step taken by NN to reduce risk in its balance sheet was its decision to do reinsurance contracts in its Dutch life segment, reducing longevity risk in its pension products related to some €13 billion of pension liabilities. By reducing this risk in its balance sheet, its solvency ratio improved by some 8 percentage points, being also positive for less interest rate sensitivity of its solvency ratio in the future.

Despite this, NN Group’s solvency ratio was 197% at the end of 2023, relatively unchanged from the previous year, as the benefit of strong organic capital generation and its longevity transaction was offset by market movements and capital returns to shareholders.

This solvency ratio is quite good and broadly in-line with the average of the European insurance sector, thus NN Group is able to return most of its annual capital generation to shareholders.

Indeed, the company has a very good capital return history over the past few years, both through dividends and share buybacks. Its last annual dividend was €3.20 per share, paid in an interim dividend of €1.12 per share and a final dividend of €2.08 per share, representing an annual increase of 14.7% YoY. At its current share price, NN Group offers a dividend of about 7.1%, which is quite attractive for income investors.

On top of this dividend, the company also repurchased shares in the amount of €250 million, leading to total capital return of about €1.05 billion in 2023. For 2024, its guidance is to grow its dividend by some 12.5% compared to the previous year and perform a share buyback program of €300 million, increasing total capital returns to €1.2 billion.

While a high-dividend yield can sometimes be a sign of poor dividend sustainability, this is not NN Group’s case. Its dividend is more than covered by its organic free cash flow generation, which amounted to about €1.4 billion in 2023, and is expected to grow to some €1.6 billion by 2025. This means NN Group is generating enough cash to finance its dividend policy and share buyback programs, plus retaining some cash at the holding level due to a conservative approach.

Therefore, its dividend is clearly sustainable and has good growth prospects over the coming years, a profile that seems to also be acknowledged by the Street. Indeed, according to analysts’ estimates, NN Group’s dividend is expected to grow over the next few years, to about €3.88 per share by 2026, which can improve even further its dividend yield in the medium term.

Valuation & Risks

Regarding its valuation, NN Group is currently trading at only 0.65x book value, an undemanding valuation compared to its closest peers, but in-line with its historical average over the past couple of years, even though its profitability has improved somewhat in recent years.

On a relative basis, I see ASR Nederland and Ageas as the best peers due to their focus on the Benelux insurance market. Both competitors are currently trading at around 1.2x book value, potentially showing that NN Group is undervalued.

However, NN Group’s profitability has been historically much lower than compared to its peers (return on equity on average of about 6-7% vs. double-digit levels for its peers); thus I think it’s also necessary to perform an absolute valuation, to see if NN is really undervalued or not.

Using the Gordon growth model, and assuming a cost of equity of around 7%, based on its historical beta of 0.7x over the past couple of years and a risk-free rate of 2.86% (10-year Dutch government rate), its fair value is close to book value. This shows its shares are currently undervalued, even though some discount to peers is still justified by a lower profitability level.

Regarding risks, investors should note that life insurance companies usually have longer duration in the liabilities side than in the assets side, creating a duration mismatch. This is negative for Solvency ratios during periods of lower rates if insurance companies don’t hedge interest rate risk. NN Group is aware of this and hedges to some extent interest rate risk, but this may not be a perfect hedge and lower rates ahead may have some negative impact on its Solvency ratio and, therefore, its ability to pay dividends and perform share buybacks in the future.

Another potential risk that shouldn’t be overlooked is wider credit spreads given that current spreads are relatively tight compared to historical levels, thus a widening of credit spreads can lead to some investment losses in its bond portfolio and also impact negatively its Solvency ratio.

Conclusion

NN Group has a large exposure to mature insurance markets and its growth prospects are therefore quite low, making its investment case highly exposed to capital returns. Indeed, it offers a high-dividend yield and is also repurchasing its shares, being the most attractive feature to shareholders. Additionally, its valuation also seems to be undemanding both on a relative and absolute basis, making NN Group an interesting income option in the European insurance market.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.