Earnings Call: Q3 2022

Nov 30, 2022

Summary

Core operating income grew, but capital-market losses drove 9M comprehensive income to ILS 599 million and Q3 income to ILS 62 million. AUM reached ILS 364 billion, solvency improved to 202%, and the medium-term ROE target remains 12%-15%.

Hello, this is David Alexander, Deputy CEO of Phoenix Holdings. Thank you for joining us today for the group's financial review for the third quarter of 2022. The call will be led by Phoenix Holdings CEO, Eyal Ben Simon, and CFO, Eli Schwartz. The presentation for the call can be found on our website or the Tel Aviv Stock Exchange website. This presentation provides key points on the financial statements released this morning and should be read together with the full financials. At the end of the call, we will answer questions that were discussed today on the Hebrew call. You can send any additional questions to us individually or to the email address ir@fnx.co.il. The address also appears at the end of the presentation. We will also make ourselves available to meet individually with investors to discuss performance, strategy, or answer any questions that you may have. Please note that the call will include forward-looking statements and that actual future results may be different. Eyal Ben Simon, CEO of Phoenix Holdings, will first present the main results for the third quarter. Eli Schwartz, the group's CFO, will then review the financial performance in more detail by segment. Hello, and thank you for joining the call today. The Phoenix is a leading financial group in Israel with four core businesses: insurance, asset management, credit, and distribution of financial and insurance products. The group has strong growth and performance, a strong balance sheet and solvency ratio, and over ILS 360 billion or $100 billion under management. Israel's economy continues to perform very well compared to key OECD peers with continued strong growth. Inflation is roughly 5% for the last 12 months, significantly below international averages. This is due to structural factors as well as domestic production and natural gas with long-term pricing. The Bank of Israel is continuing the process of increasing interest rate, but with the latest increase being half percent. Still, the increase in inflation and the continued increase in interest rates brought increased uncertainty and capital market volatility during the quarter. Market conditions negatively impact our results in the third quarter and in the first nine months of the year. But we are very optimistic about the medium and long-term trends of the Israeli economy, including high rates productivity, continued increase of assets under management, and continued innovation in a dynamic economy. Despite the effects of the capital markets, The Phoenix delivered a return on equity of 8.4% in the first nine months of the year and income of ILS 599 million. In the third quarter, the return on equity was 2.6% and income was ILS 62 million. Assets under management are stable and in some areas growing, reaching ILS 364 billion, over $100 billion. This performance and the dividend distributed during the quarter based on the first half results reflect the stability of the group and its ability to generate income and cash during volatile conditions. The first nine months of the year saw continued profitable growth in our core businesses, including asset management, distribution, and credit, as well as insurance. We are driving growth and higher operating income across these segments while improving efficiency in the insurance business. One example is SME credit company Gama, which reported significant growth and higher income after investing in capabilities, capital optimization, and infrastructure during the last year. At the same time, the group continues to show financial strength and resilience. We continue to manage exposures dynamically, with income from rising interest rates partially offsetting the negative investment impact. The solvency ratio of Phoenix Insurance increased from 190% in December 2021 to 202% in June 2022, reflecting strong capitalization and a strong balance sheet. This financial strength is creating broad opportunities, especially given capital markets volatility. We continue to look at possible acquisitions, value creation opportunities in our business, and after the end of the quarter, we signed an agreement to acquire Epsilon Investment House, an active fund managed in Israel. We break down income from core businesses versus the effect of investment and interest rates and special items. Total comprehensive income in the first nine months of the year was ILS 599 million, here on the right side, with strong growth in both the insurance in dark blue and the additional activities in orange, compared to last year, which is the key indicator of improving performance. We see the negative impact from the capital markets and positive special items. Similarly, in the third quarter, comprehensive income was ILS 62 million. Here, we also see continued growth in the income from the core businesses. Given the market volatility, our focus on growing income from our core businesses and shifting the mix to fee-based income from the additional core business is driving long-term growth and reduced volatility. It allows us to produce positive results even with such significantly negative market conditions, and it builds the platform for the future. As of the end of the third quarter, our assets under management stood at ILS 364 billion, over $100 billion. The stability, actually 1% growth during the quarter, is despite negative market returns. It is due to strong net inflows across our activities and the capabilities we are building in retirement and long-term savings, including our track record, service, and branding. Total premiums and contributions continue to grow across the group. Both in the quarter and in the first half, we see growth compared to last year, including in P&C, which is dark blue, and pensions. Our shareholders' equity stands at ILS 9.6 billion after the semi-annual dividend distribution in September. We are building a track record of dividend distributions under our dividend policy while we are optimizing our capital position. Our solvency ratio has grown from 190% at the end of December 2021 to 202% at the end of June 2022, highlighting the strong and improving capital position of insurance company. Excess capital grew by ILS 400 million after reconfirmation of transitional measures. We should note that the opposite transitional measures, we have back book runoff, which will release a reserve over the same period, and we use a standard model, not an internal model. The group also has high liquidity at the level of Phoenix Holdings, supporting acquisition and growth, as well as continued dividend distributions. We continue to implement our group strategy across the four growth engines: insurance, asset management, distribution of financial insurance products, and credit, of course. The strategy consists of four value drivers. The first is accelerating growth in high ROE activities and shifting our mix to more valuable capital-light activities. Second, we continue to organize for innovation, efficiency, and client satisfaction, deepening our competitive advantage. Third, we actively manage the group and our business portfolio to unlock and create value. Fourth, we are increasingly deploying capital effectively against our priorities to reduce volatility and generate higher returns. We manage each of these value drivers across the main group activities. We can see a number of examples of the strategic advancements we made during the first 9 months of the year. We continue to show strong growth in P&C, asset management, agencies, and credit. Second, we are investing in innovation and analytics and continuing to transform our organization and activities. Third, we continue to make acquisitions. This includes acquisition of smaller agencies that we add to our platforms with high synergies. A few weeks ago, we signed an agreement to acquire boutique investment house Epsilon, which has a strong active mutual fund and portfolio business. For some time, our active fund management business has been smaller than our passive fund businesses, and this acquisition will allow us to achieve scale, improve capabilities, and become a stronger mutual fund player. Fourth, we continue to optimize our capital position and deployment across the group. In this context, we should emphasize that beyond growing our income from activities, we are fully committed to unlocking the significant value of key activities that is not reflected on our balance sheet. This is a long-term process. We have had important achievements at Gama, at Ad 120, the senior resident house, Phoenix Capital, and in real estate, and we continue to work on unlocking significant value in a systematic way. Regarding our targets, clearly, capital markets are having an impact this year. You can see that in our income and our return on equity. Despite the impact of the capital markets, we are on track to reach the strategic targets we have set for the group. We believe that these targets are achievable in this timeframe, and regardless of the cycle that we see in the markets, we believe that our growing income from activities puts us in a strong position going forward. In the insurance business, our P&C premiums continue to grow, and we expect to be on track for well over ILS 4 billion in the medium term. Expense ratios are at or near targets, and we continue to improve as we grow. Solvency is above target, creating significant flexibility going forward, and the income from the insurance business continues to grow. In the additional core activities, we are also improving toward our targets. The pension and provident business is well above the same period last year and continues to grow. Investment services, which includes Excellence and the private client alternatives, is also well above the same period last year and in sight of the target on an annual basis. The agencies are also well above the same period last year. Overall, the income from these fee-based business is over ILS 280 million for the first nine months of 2022, and in line with our strategy of shifting from insurance to growing share of fee-based income. Given the volatile market conditions, going ahead, we are staying focused on our strategy. We are growing the core businesses, increasing margins and income, and shifting the mix as we diversify. We are also looking at external opportunities, even as we continue to invest in our people and capabilities. And of course, we are actively managing our investment and exposures as the market shifts. Now, I would like to hand over the presentation to Eli Schwartz, the group's CFO, who will review the financial results and segments in more detail. Please, Eli. Thank you, Eyal. The total pre-tax income in the first nine months of 2022 was ILS 841 million. On the left side, an increase was recorded in income from operation, which reached ILS 1.3 billion, ILS 369 million more than in the first nine months of last year. We can see the improvement in all areas, including insurance underwriting, pension and provident funds, agencies, and credit. On the right side, we see the negative impact of the investment over ILS 2 billion compared to 3% real returns. This is offset significantly by interest rate effects, creating a net negative financial margin of ILS 721 million before tax. During the third quarter, the total income before tax was ILS 102 million. On the left, the income from operation was ILS 412 million, of which ILS 264 million was from insurance underwriting and ILS 148 million was from additional core business. All business segments grow compared to the third quarter of last year. On the right, we see the negative ILS 269 million pre-tax financial margin, driven by negative investment income offset by positive interest rate effects. Looking on the breakdown of the first nine months of the year, we see that the additional core business contribute more than half of the income of the period. On the left, insurance saw income from health and life to large extents due to interest rate effects on the LAT reserve. The loss in the P&C is mainly due to capital market. On the right, we see a strong contributions of a growth in a key segment, pension and provident, investment service, and agencies, all growing significantly compared to the same period last year. The credit segment also grew in terms of operation income, and the decrease is due to the one-time profit from acquiring control of Gama last year. Similarly, in the third quarter, overall group income from the additional core business, mainly because of the negative capital market effect on the income from the insurance company. All insurance segments were profitable in the quarter, including P&C, health, and life. However, equity losses had driven down insurance income for the quarter. In addition, core business, we see improvement and stability of fee-based income, which is less exposed to the market and drove group profitability for the quarter. The Phoenix balance sheet continues to show strength, and total equity has grown since the beginning of the year. This provides financial strength of the group and debt mix based mainly on fixed interest rate during volatile period and can support capturing opportunities going forward. We will now review each segment in more detail. The P&C segment continues to face challenging cycle, but it is improving in line with the company expectations. During the first nine months of the year, underwriting profit was ILS 119 million, with an overall loss due to capital market effect. For the third quarter, however, we see underwriting profit of ILS 42 million, with an overall positive income of ILS 50 million due to interest rate offsetting investment. In the motor segment, we see improvement market condition when comparing the first and the third quarter. We expect improvement condition to be further reflected in the coming quarters. The health segment benefits from a rise in interest rate this year, contributing ILS 948 million year to date, and ILS 105 million during the quarter. But more important is the strong underwriting profit, which has grown from ILS 189 million last year to ILS 227 million this year. The life segment continues to contribute ILS 496 million year to date, with ILS 216 million underwriting profit. During the quarter, life contributed ILS 60 million in underwriting profit. Other equity returns are the significant negative impact of ILS 958 million pre-tax income year to date, and negative ILS 202 million in the quarter due to investment and capital market effect. The additional core activities, starting the asset management, are growing year on year, and with a much lower volatility and smaller capital market impact. In the pension and provident segment, we see growth year to date from ILS 43 million last year to ILS 73 million this year. The investment service segment contributed ILS 182 million income before tax year to date. Of this, ILS 113 million was from operation compared to ILS 107 million last year. Growth during the quarter was from ILS 30 million last year to ILS 35 million this year. The agencies segment continues to grow both organically and inorganically. Agencies contributed ILS 238 million pre-tax income year to date, compared to ILS 173 million last year. During the quarter, we see growth from ILS 62 million to ILS 64 million this year, and growth of ILS 53 million to ILS 65 million profit from operation. Gama continues to grow in activities and credit portfolio. The portfolio is now over ILS 1.9 billion, up from ILS 1.4 billion at the beginning of the year. Similarly, transactions volume are 18% higher than a year to date in a similar period on the right. Gama contributed ILS 48 million pre-tax income year to date, of which ILS 24 million was in the third quarter. This is significant improvement in performance as the business grows top line on emerging after increasing the capital and building infrastructure and capabilities over the past year. In the current environment, Gama is actively managing credit risk and is balancing growth with careful approach. Other items contributed ILS 5 million year to date. We will now review the questions that were discussed in the conference call in Hebrew. If you have additional questions, you are invited to contact us, and we will be happy to answer or schedule time to discuss. The first question is about the impact of capital markets and the volatility of earnings. There is significant variation in the company's quarterly results. The profit in the quarter is positive, but lower in relation to the past. Why is that, and what are you doing to improve? What is the indicative income and the indicative return on equity for the business? Hi again. Indicative long-range income includes three elements, three main elements. First is the income from activities. The second one is income from investment above 3% real yields. And the last one is income from systematically unlocking value. We published in our medium-term strategic plan a 12%-15% ROE target, and we think that this is a good indication for the long-term profitability or the long-term return on equity that we believe in. Actually, if we divided those three elements and actually explain each one of them, we can see that we managed to grow and improve the first element, which is income from activities. And as we believe, we have the best division for investments in Israel, and also with a lot of capabilities of doing investments out of Israel to achieve above 3% real yields, although this is actually the long-term real yields that we believe or we actually put in the plan. And as we have spoken today, and we have shown already in the past, we know how to unlock value through systematically transactions or value creation plans like we did in Gama, like with our senior resident house, Ad 120, and so on. Second question. From the end of the third quarter to today, the Bank of Israel has raised interest rates. As a result, are you expecting to see a significant positive effect in the following quarters, which will continue to offset the results of investments? We have a 404 million ILS LAT reserve that are sufficient reserve to support continued positive effect of increase in interest. However, keep in mind, it is driven by the market yields curve and not the Bank of Israel rate. Third question. We've recently seen that interest rates in Israel and abroad have led to valuation losses in real estate companies and to expectations of lower asset values. How do rising rates impact The Phoenix's real estate assets? Well, over the past three years, our investment team has restructured our real estate portfolio from direct assets to investments in platforms and real estate companies. We expect to see some impact on remaining direct assets valuations and some impact via holdings in real estate companies. However, we try to invest in strong management teams with financial resilience and good assets, and I believe that in the near future, probably as I said, there would be an impact of the increase of the interest rate, but for the long term, our investment or our strategy to invest in platforms rather in specific assets will eventually create much more value to the group. Next question. In view of the market conditions, do you still feel comfortable with the goals of the medium-term strategic plan? Yes, sure. We are overall on track and even above targets in some areas. You can see growth in our profit from core insurance and non-insurance activities. The impact of capital markets is what we believe is a cyclical event. Markets will eventually recover, whether it will take a half year, or year and a half, and we have every intention of meeting those targets, as we spoke in this meeting about meeting our targets, and we totally believe that we will meet our targets in the medium term. Next question. Will you change the dividend policy as a result of the improvement in solvency? Improving in solvency and in general, our strong balance sheet and liquidity support our dividend policy. Our current policy is at least 30%, so it is flexible. We examine both the policy and the actual distribution from time to time and will make decision based on what is appropriate, providing attractive dividend for shareholders while building our capital and capturing strategic opportunities. What factors have led to stronger performance in the P&C business, and can it be expected that this segment will be profitable in the future? Do you expect that? If so, when do you expect profitability in the vehicle business as it was before? Well, definitely we have seen a cycle in the last 12 months driven by both frequency and severity, mainly on motor property, but also on other segments as well. We have seen that in the past, although this cycle is a bit stronger, but we totally believe and we build capabilities to deal with it and to manage it, that in the near future, I believe 2023 already, we will see recovery in all P&C segments, definitely in the motor property, which actually was the main segment that was damaged from the changes, from the inflation and so in the market. I believe that 2023 would be much more positive than 2022, and I believe maybe even of 2021. Those were the questions. You are welcome to contact us directly with additional questions, either any one of us individually or at the email that you see on your screen, ir@fnx.co.il. We will be happy to answer questions or schedule a meeting or a Zoom call to discuss. Finally, we would like to mention that you will find this presentation and the other materials, including a recording of this call, on our website. The recording will be up tomorrow. The presentation is up already. Thank you very much for joining the call.