Discovery’s spending spree eats into profit
The financial services group experienced a spike in life insurance claims, and also invested in its bank and other new business initiatives
A spike in life insurance claims, and investment into its bank and other new business initiatives made a dent in Discovery’s bottom line in the six months to end-December 2018.
Despite collecting R18.5bn in insurance premiums after paying reinsurance costs, the financial services group reported a 14% decline in net profit to R2.3bn for the period.
The main culprit was expenditure on new initiatives, which ate up 21% of the group’s earnings. The company borrowed more to fund these initiatives, resulting in an additional R291m in finance costs.
"The results were characterised by three themes," said Discovery CEO Adrian Gore on Tuesday. "The investment in new initiatives, strong performance in our emerging businesses, and the Discovery Life result."
The development of Discovery Bank has run slightly over budget, rising to R2.62bn from the previously indicated R2.41bn.
"We had no idea what we were going to build when we initially sought approval for the budget from the board. The end result is more powerful than we originally envisaged and we are happy with it," said Gore.
The bank will begin migrating Discovery card holders onto the platform from March. "It will be a slow burn initially as we monitor and ensure everything is working, and from there we will look to speed things up in terms of client acquisition," he said
Discovery Bank's investment hurdle is the risk-free rate plus ten percent, which equates to a return on equity of about 20%. Gore says he will be satisfied if the bank achieves this once sufficiently established.
Discovery Life experienced a spike in death claims, which trimmed 8% off the group’s earnings. The insurer said Discovery Life has since altered its reinsurance structures to reduce large-claim volatility in future.
Gore said that in response to the spike Discovery Life had made some "minor" adjustments to its reinsurance policy, and management was satisfied it had removed similar volatility from future results.
The biggest business unit, Discovery Health, increased its new business annualised premium income by 2.9% to R3.4bn and posted operating profit of R1.4bn as the business unit's lives under administrations exceeded 3.5-million.
Discovery said the accounting treatment of its new head office lease also played a role in the decline in earnings. The company said that international financial reporting standards required it to recognise a higher charge for rental in the earlier years of the lease. It said that if it were to adjust its financial statement, removing the effect of the new head office lease, its normalised headline earnings would be R102m higher than reported.
The short-term business, Discovery Insure, recorded a 325% increase in profit to R51m after collecting 21% more premiums compared with the first half of the 2018 financial year, thanks to the launch of the new commercial insurance division.
Discovery's share price closed 0.5% higher on Thursday at R145.95 per share, reflecting a market capitalisation of R96bn. This reflects a premium of 41% above its stated embedded value of R68bn.
Warwick Bam, head of research at Avior Capital Markets, thinks the premium is still justified.
“There are a number of aspects to Discovery’s business that are not captured in embedded value, including Discovery Bank and Ping An for example. Embedded value also does not give a view of new business growth. I think the new initiatives will contribute meaningfully to future earnings," he says.
Correction: February 22
The article has been corrected to reflect that the 3.5-million beneficiaries are individuals under Discovery Health's administration not members of Discovery Health Medical Scheme. The medical scheme only has 2.8-million beneficiaries.