Lloyds Banking Group's integration of its Scottish Widows and Clerical Medical insurance businesses could herald a new round of insurance mergers, Cazenove suggests today.
As a result the broker has upgraded its recommendations on a number of companies in the sector. Caz said:
"The UK life sector has rallied strongly from its lows, but we believe there is potential for significant further upside, driven by improving fundamentals, a more benign investment background, a recovery in earnings, re-rating potential, and probably consolidation as well [which looks increasingly likely].
"Industry overcapacity remains, but there are now the twin catalysts of a new market leader (Scottish Widows) and the threat from bottom feeders. Scottish Widows' potential emergence as a scale player with competitive advantage challenges the strategies of former leaders. Mid-tier players risk both being left behind by Scottish Widows, and being acquired by a consolidator if they do nothing.
"The integration of Scottish Widows and Clerical Medical could trigger a similar round of UK life consolidation [to the wave which followed the merger of Royal Insurance and Sun Alliance in 1996] if competitors come to recognise that they could be at a competitive disadvantage to the enlarged Scottish Widows group. Widows' management appears to be going about the integration in such a way that the delivery of a group with competitive advantage appears credible.
"If a major deal were announced, driven by cost savings, we have little doubt that others would follow. Competitive advantage is about relative rather than absolute scale, and if a merged entity threatened to use its efficiency to offer better terms, or else delivered superior returns, the pressure on others to merge would be immense. Moreover, with no new entrants, consolidation is a one-way street, so incumbents should consolidate sooner rather than later
before there are no partners left."
So Caz has upgraded Aviva, down 8p to 413.5p after going ex the 9p a share dividend, Prudential, up 17p to 581.5p and St James Place, down 0.6p to 234.2p, from in-line to outperform.
