Is FTSE 100 Stalwart Admiral a Good Value?

LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If shares are bought when they're cheap, two drivers could move the price up: growth in earnings and an upwards P/E rerating.

Highly successful fund manager Peter Lynch classified steady growers as "stalwarts," which he typically traded for 20% to 50% gains. But whether buying for gains like that or holding for the long term, we need to know whether reliable earnings growth can continue and the shares are cheap.

Seeking durable growth
Not all companies achieve stable growth, as you can see by the aggregate performance of those in London's premier FTSE 100 index (INDEX: ^FTSE  ) , where the compound annual earnings growth rate has been just 0.7% over the last five years:

 

2007

2008

2009

2010

2011

2012

FTSE 100 Index

6,608

5,626

4,249

4,917

5,946

5,571

Aggregate Earnings per Share (pence)

537

503

427

397

527

557

Consistent, cash-flow-backed growth in profit is a promising characteristic in today's markets, so for this series I'm examining companies with annual earnings growth between 4% and 20%.

One contender is Admiral Group (LSE: ADM.L  ) , which is a vehicle-insurance provider. This table summarizes the company's recent financial record:

 

2007

2008

2009

2010

2011

Revenue (millions of pounds)

233

301

386

575

960

Earnings per Share (pence)

48.6

54.9

59

72.3

81.9

Earnings have grown at an equivalent 13.9% compound annual growth rate, putting Admiral in the "stalwart" category.

Since it launched in 1993, Admiral has grown from a small start-up to one of the largest car insurance providers in the U.K., with a presence in seven countries. Based in South Wales, the firm started with 57 employees and now employs around 6,000 people worldwide.

Brisk growth means the company insures more than 3.4 million vehicles. In 2011, revenue rose 38% to 2.19 billion pounds, which includes some from its popular price-comparison business, Confused.com. But by far the biggest source of revenue is U.K. car insurance, at 90% of the total, followed by international car insurance at 6% and comparison and other businesses at just 4%.

The firm uses reinsurance partners to mitigate underwriting risk and returns much of its annual profit to shareholders in the form of special dividends.

The flamboyantly named CEO, Henry Engelhardt CBE, uses amusingly flowery language in the company's financial reports. He recently quoted Dickens' A Tale of Two Cities to describe the firm's performance, beginning, "It was the best of times, it was the worst of times..."

Admiral's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:

  1. Growth: Net cash from operations is lagging the growth in revenue and earnings. Score: 3/5
  2. Level of debt: There's net cash on the most recent balance sheet. Score: 5/5
  3. Outlook and current trading: Recent trading supports a robustly positive outlook. Score: 5/5
  4. Enterprise value to free cash flow: At 17, it's above the historical earnings growth rate. Score: 2/5
  5. Price to earnings: Around 14 and just above historical earnings growth rate. Score: 2/5

Overall, I score Admiral 17 out of 25, which encourages me to believe this stalwart may continue earnings growth that outpaces that of the wider FTSE 100. However, the shares look fully priced, considering the FTSE's price-to-earnings ratio of around 10 and the firm's growth predictions.

Foolish summary
Admiral's strong cash flow, zero borrowings, and positive outlook are attractive. However, as an insurer, the company is exposed to risks such as claims and a cyclical business that have the potential to affect future growth, in my opinion. I'd expect such risks to weigh permanently on the valuation of Admiral's shares.

Right now, forecast earnings growth is around 11% for 2013, and the forward P/E ratio is about 12 with the shares at 1,181 pence. Considering that and the other factors analyzed in this article, I think the shares look fairly priced, and the company is a good candidate for my watchlist.

Admiral is one of several stalwarts on the London stock exchange steadily growing earnings, each with the potential to deliver significant capital appreciation when purchased at sensible prices. If you are serious about capital gains, as I am, I recommend you now read "Top Sectors for 2012," in which three Motley Fool Share Advisor analysts each study a favorable industry -- and pinpoint a particular share to consider for this year and beyond. You can read the report for free today, but hurry -- it's available for a limited time only.

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Further investment opportunities:

Kevin does not own any shares mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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