Discovery and MMH look cheap ... relatively speaking

It’s two years since Rand Merchant Investment Holdings (RMI) unbundled its shares in Discovery and Momentum Metropolitan Holdings (MMH), which were both originally part of FirstRand when it was formed in 1998. 

The winner from this unbundling exercise in April 2022 wasn’t either of the life insurers but RMI itself, now renamed Outsurance, which is trading on a demanding p:e of 21. With a market cap of R62bn it is substantially larger than MMH (R29bn) and not that far behind Discovery at R80bn.

Before the unbundling RMI traded at R18; now, even without its Discovery and MMH shares, Outsurance trades at about R40. 

“The only change for the two life offices from the unbundling was that they lost the air cover of a 25% shareholder,” says former RMI CEO Herman Bosman, now chair of Outsurance.

Says Discovery CEO Adrian Gore: “The RMI unbundling made very little difference.”

Gore points out that a sizeable part of the shareholding went to Remgro and Royal Bafokeng Holdings, which “have been part of the journey over the long term, and remain committed shareholders”.

He says it is positive that the free float increased “a bit”. 

In the meantime, Discovery has fallen from R180 in April 2022, just before the unbundling, when market excitement was at its peak, to R118. This is a discount of 25% to the embedded value per share — the accepted way to value life companies — stated in Discovery’s interim results.

This is low for a group with growth potential from Discovery Bank and its multinational Vitality Group. In particular, its 25% holding in Ping An Health in China alone has an extensive runway.

Coronation senior portfolio manager Neville Chester says the house has yet to buy Discovery to any significant extent, but at these levels it looks “interesting”.

Discovery’s p:e of 11.5 hardly makes it a “growth” company.

PSG portfolio manager Justin Floor says there have been concerns about the amount of capital Discovery has sunk into Discovery Bank. 

Discovery has been one of PSG Asset Management’s top 10 shares, and he believes that the rest of the investment community is undervaluing the potential from the bank and other recent start-ups.

MMH has publicly stated it has no plans to start a bank. CEO Jeanette Marais says it will focus on what it is good at, the creation and distribution of insurance and investment products.

Her main priority this year is rebuilding — and possibly doubling the size of — the Momentum agency force.

Floor says the substantial capital expenditure on Discovery Bank is tailing off. The bank’s losses fell by 15% to R339m over the six months.

Gore says all the bank metrics are encouraging, with client numbers up 42% to 825,000, deposits up 31% to R16.7bn and advances up 20% to R5.75bn. Total revenue for the half-year is up 32% to R933m.

Discovery Bank has a loyal client base among the supporters of the Vitality shared-value model. And it sees a golden opportunity in the home loans market, arguing that it would give 60% of Discovery clients an interest rate reduction if they moved.

But banking is highly competitive in South Africa, with strong incumbents — in particular Discovery’s former parent, FirstRand. It will be a steep climb.

Momentum was listed in 2010 after its merger with Metropolitan but RMI kept a shareholding of about 25% in the combined MMH business.

The RMI unbundling has benefited MMH, whose share price has risen from R16.83 then to R21 now — though this is an even deeper discount of 40% to embedded value. 

Banking is highly competitive in South Africa, with strong incumbents — in particular Discovery’s former parent, FirstRand

The market reacted positively to the appointment of Marais as successor to Hillie Meyer. Marais was Meyer’s deputy during his second stint as CEO, from 2018 to the end of last year. They also worked closely together during Meyer’s first term as CEO from 1996 to 2005.

Together they boosted market perceptions of what was looking like a mediocre mid-sized life office, with arguably only one market-leading business — Guardrisk, which allows retailers and other corporates to set up their own insurance operations on the Guardrisk licence. 

This unit produced normalised headline earnings of R360m for the six months to December, a modest 3% increase, but gross written premiums rose 24% to R2.59bn.

It is certainly impressive relative to the motor-based short-term insurers in both groups. Momentum Insure made an operating loss of R4m, and only contributed to earnings through R35m in investment return. Discovery Insure scraped together R20m in normalised earnings — a drop in the ocean compared with the 800lb gorilla Outsurance’s R1.41bn in earnings over the same period.

Chester says Coronation’s Houseview portfolios own shares in MMH as it is cheap on a p:e of eight and a dividend yield of 6.2%, and while it has challenges some of these will be relatively easy to sort out.

Metropolitan Life, for example, has faced a serious threat from Capitec’s cheap-and-cheerful funeral policies, but it has already bounced back with a 49% increase in normalised headline earnings to R299m, helped by a decline in funeral and life policy lapses. 

Metropolitan seems to be constantly restructuring its sales force, with tied agents capped at about 3,200. MMH CFO Risto Ketola says the number of experienced advisers (those with more than 12 months’ experience) is stable. Funeral policies is a sector in which Discovery doesn’t compete, and shows no signs of wanting to do so.

Discovery has faced considerable headwinds. Floor says the prospect of National Health Insurance (NHI) scares off foreign investors. 

In the six months to December 31 2023 Discovery Health accounted for more than 40% of the operating profit of the South African section of the group, or R1.87bn. This was up 7%. And it is by no means a mature business, as new business increased 52% to R6.8bn, though this figure was boosted when Sasolmed, Sasol’s in-house medical aid, was taken onto the platform.

If NHI is implemented, medical aids will be restricted to offering services that the government doesn’t offer; in effect gap cover rather than comprehensive medical cover.

But Floor says that this is already “in the price” especially as NHI, if it is implemented at all, will take five and possibly 10 years to become reality.

MMH is the only other life office with its own medical aid operations, Momentum Metropolitan Health — though Sanlam has a shareholding in Medscheme, South Africa’s other significant medical aid administrator. Momentum Metropolitan Health even has a clone of Discovery’s Vitality, called Multiply, offering what is clunkily called “incentivised wellness”.

This is targeted not just at members of Momentum medical aid scheme itself but at in-house corporate schemes and the Government Employees Medical Scheme (GEMS), which MMH administers.

Ketola says there was a 4% increase in overall membership thanks mainly to a 5% rise in GEMS membership and an 18% increase at the stripped-down Health4Me product.

The Momentum medical scheme itself recorded a 2% decline in members.

But compared with Discovery Health, Momentum Metropolitan Health is a minnow; it made R150m over the six months to December, down 17% on the previous interim period.

The cultures at Discovery and MMH are very different in spite of their common parentage. 

Discovery has only acquired one significant business in its 32 years — Standard Life Healthcare in the UK. MMH has taken over multiple businesses over the years, two of them — Lifegro and Southern Life — much larger than itself.

Former FNB CEO Michael Jordaan once described Discovery as the “enfant terrible” of the group, because of its disruptive entrepreneurial culture — attributes that Jordaan must admire, given his own business journey.