The Investment ColumnBrokers miss the party

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The Independent Online
Insurance brokers have completely missed the stock market party of the past few years. One hundred pounds invested five years ago in the sub-sector, which ranges from the mighty Sedgwick to the lowly PWS, would now be worth something like pounds 64.

The reasons for this dismal performance are not hard to find. Normally a highly cyclical industry, insurance rates have been weakening almost continuously since the early 1990s. But whereas in a normal cycle weaker players would eventually be driven out, there has been less evidence of capacity cuts this time and the outlook is for soft rates to continue for the foreseeable future.

It was therefore with considerable relief that the market heard the news last month that Lloyd Thompson and JIB, two of the largest second-line brokers, had agreed to merge to create Jardine Lloyd Thompson. Expectations that that would be part of a consolidation trend appeared to be confirmed yesterday when two of the smaller players, Lowndes Lambert and Fenchurch, were forced to admit they were in merger talks after the latter's shares started to move earlier this week. Fenchurch, which traded at 49p at the beginning of the week, added a further 8.5p to 66.5p, while Lowndes put on 7p to 110p on the news.

Any merger is likely to be defensive, given that growth is more likely to come from cost-cutting and market share gains than any expansion of the top line. Tony Silverman, insurance analyst at NatWest Securities, expects market growth to be in the low single-digit per cent over the next few years. He estimates there could be scope to shave at least 5 per cent from the combined costs of the two brokers, put at around pounds 115m.

Beyond that, though, Fenchurch also looks in need of Lowndes' management skills. Revenue and operating profits have grown sluggishly since 1991 and last year was torrid, with a profits warning and the defection of a team of South American specialists in February followed by a halved final dividend and the loss of a chunk of business in the autumn.

The logic behind the JLT merger looks more soundly based. Lloyd Thompson's highly successful London market-based business should fit nicely with Jardine's extensive foreign network and its strong links with the Far East, one of the few insurance markets still showing reasonable growth.

JLT, when it finally emerges, should be a reasonable bet for the long term, but punters hoping to catch the next wave of consolidation could take a look at Nelson Hurst, a group with the sort of international coverage that might attract a bid from a more London-orientated broker. Mr Silverman also points to the potential for slimming down overheads at CE Heath, where costs have been traditionally higher than average. The shares, unchanged at 96p, stand on a forward rating of under 8. But the overall sector is likely to continue to be dull, particularly in view of the impact of the higher pound on overseas earnings.