Margin Pressure Impacting On QBE

This story features QBE INSURANCE GROUP LIMITED. For more info SHARE ANALYSIS: QBE

– QBE revises down earnings guidance
– High number of large claims
– Margins remain under pressure given tough operating environment
– Brokers see little scope for short-term outperformance 

By Chris Shaw

The first half of 2011 has been a difficult one for QBE Insurance ((QBE)), as the company has faced an unusually large number of large claims given the number of catastrophes so far this year. Based on this earnings impact management updated the market yesterday, guiding to 1H11 net profit of US$660-$704 million.

While this implies a result 50-60% higher than for the previous corresponding period, the guidance was below market expectations. As an example, Deutsche Bank had been forecasting an interim profit of US$870 million while others had been around the US$750 million range.

Even allowing for the higher frequency of claims in the period, Deutsche Bank notes there have been offsetting factors such as higher investment yields and foreign exchange gains. This implies softer underwriting margins, which has been picked up on by most brokers.

On Deutsche's numbers underlying margins for the half have been around 12.5%, which is well below full year guidance for margins of 15-18%. While BA Merrill Lynch estimates 1H11 margins of 13.2%, RBS Australia suggests an outcome for the period of 12.8%.

While an improvement to 15.9% for the second half is anticipated by RBS Australia, this still suggests a full year margin of 14.5%. This would be a little below current guidance for margins for the full year of 15-18%. BA-ML agrees, estimating full year margins are likely to come in around 14.7%.

The updated guidance by management has seen brokers adjust earnings forecasts for QBE, with RBS Australia cutting FY11 estimates by 5% and Deutsche Bank by 8%. BA-ML had previously lowered estimates, so it has only cut a further 2% from forecasts. Estimates for outer years have also been trimmed by most in the market, but by smaller amounts.

Consensus earnings per share (EPS) forecasts for QBE Insurance now stand at US159.8c for FY11 and US179.2c for FY12. The changes to forecasts have been accompanied by some changes to price targets, with RBS Australia cutting its target to $19.22 from $20.07 and Deutsche Bank to $18.20 from $18.50.

The consensus price target according to the FNArena database now stands at $19.57, down from $19.72 previously. Targets have a reasonable spread, ranging from Deutsche at $18.20 to Macquarie at $20.77.

What hasn't changed is broker ratings, the database showing QBE Insurance is rated as Buy twice, Hold five times and Underperform once. UBS is among the Buys, continuing to see value in the stock at present levels despite currently unfavourable conditions.

The Hold view is well summed up by BA-ML, the broker suggesting there are few reasons to expect outperformance at present given interest rates are again trending down, the Australian dollar remains strong and there are the higher claims impacting on margins.

Deutsche Bank agrees, pointing out while at current levels QBE Insurance is trading at a 20% discount to its seven-year average 12-month forward earnings multiple, there is limited upside potential in the shorter-term.

Even while expecting recent acquisitions to add to underlying growth, RBS Australia also sees a difficult shorter-term environment for QBE Insurance. The broker suggests it will take a recovery in markets for the stock to re-rate, something not expected to occur in coming months.

Shares in QBE Insurance today are weaker and as at 11.05am the stock was down 61c or 3.5% at $16.67. Over the past year QBE has traded in a range of $16.09 to $19.60, the current price implying upside of around 18% to the consensus price target in the FNArena database.

 
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