QBE Shatters Investor Confidence

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

– QBE issues warning, share price tanks
– Earnings opaqueness keeps brokers concerned
– Management possibly conservative, but caution rules

By Greg Peel

“Today’s QBE profit warning is a painful reminder that micro can quickly overwhelm macro in opaque turnarounds,” says UBS.

For a long while QBE Insurance ((QBE)) struggled against near-zero interest rates in the US, a strong Aussie dollar and a burst of higher than average catastrophe claims. This year, however, light was seen at the end of the tunnel by long suffering investors as the Fed flagged stimulus tapering (leading to a bounce in US rates), the Aussie dropped around 14% and catastrophes appeared to be well contained. Indeed, long-term insurance watchers were keen to point out that “cats” tend to cycle, such that a period of extensive claims is usually followed by a quiet period.

This is where insurance companies can outperform, given prior high cats justify premium increases into a period of low cats. But then QBE is not just about said “cats”. It’s about workers comp and crops and a lender-placed business, among other things.

When the macro story began to turn around, investors were quick to jump on QBE. Never mind that it’s very difficult to predict claims activity across the range of insurance activities the company engages in in North America. As UBS notes above, this difficulty renders QBE’s supposed turnaround “opaque”. Investors were prepared to back the “macro” (rates, AUD) and pay scant attention to the “micro” (claims et al).

And so it was the company issued a profit warning before the market open yesterday, and the share price plunged 22%.

QBE downgraded its profit guidance, last updated post the August interim result release, to a US$250m loss due to claim provisions and write-downs in North America. Behind this number was a $300m provision increase for prior accident year claims development relating to workers comp, general liability and construction defects risks. US crop insurance claims rose by 11% last quarter due to materially lower crop prices. Some $150m has been apportioned to restructure the lenders-placed business along with $330m in intangibles write-downs.

And $600m of US goodwill has been written down. Bit light, suggests Macquarie, given the $2.354bn ascribed to North America goodwill at the 2012 result.

Investors may be angry about the downgrade but red-faced stock analysts are far from amused. Ahead of the warning, four of eight FNArena database brokers rated QBE Buy (or equivalent) and only one rated Sell. JP Morgan (Underweight) rates stocks on a sector-relative basis. What has changed so materially since the interim result? analysts ask. This rapid deterioration in profitability since August is a concern, UBS suggests. Says Credit Suisse:

“With reserves less than US$1bn a year ago, we remain confused at how the provisions have increased to excess of US$1.5bn today. We assume management has this time taken an extremely conservative approach to reserving; however, we have no supporting data to back up this view.”

QBE’s guidance for FY14 implies that the issues have not yet been resolved, CS adds.

Not surprisingly, analysts have slashed their earnings forecasts and their target prices. The FNArena consensus target price has fallen to $14.79 from $16.36 prior. However, both JP Morgan and Deutsche Bank (Buy) are yet to update their views and targets. If we drop those two out, the consensus target becomes $12.98.

But with the stock down 22% yesterday, where is QBE sitting in value terms now?

The focal point of QBE’s earnings is its net margin, expectation for which management yesterday downgraded to 6% from 11% in FY13. The preliminary target for 2014 is 10%. UBS believes that 10% is achievable but “remains cautious”. BA-Merrill Lynch believes 10% is too conservative and has pencilled in 11.5%. Credit Suisse suggests that on the assumption North America recovers next year, and expenses are successfully pulled out of the group, an insurance margin recovery of some 300 basis points can be achieved from the current 2014 base.

CS has thus retained its Outperform rating, given yesterday’s share price rout. UBS and Merrills have both stuck with Neutral.

CIMB cites a lack of confidence and ongoing issues across the North American portfolio that are more widespread than previously envisaged in downgrading to Hold. Macquarie cites “insufficient visibility on the earnings outlook” as its reason to downgrade to Underperform. Despite improving macro conditions, this visibility issue offers up a “high potential of material variation from current forecasts,” the broker warns.

That leaves us with only two Buy ratings, although one is still up for reconsideration. There are also two Sells, ditto. Four Holds make up the balance.

At the time of writing, QBE is down another 6.6% in today’s trade.

When backing the macro, do not neglect the micro.

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