Brokers Pick Over Insurers’ Prospects

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

-Need to pick least overvalued
-Worst likely over for QBE
-Key to IAG is margin delivery
-Key to Suncorp is capital returns

 

By Eva Brocklehurst

General insurance growth trends in Australasia have eased this year, with softer premium rates exposing the fact that volumes are tough to obtain. Industry gross written premium (GWP) growth slowed markedly over FY14 and listed peers fared worst, in JP Morgan's observation, with personal lines the main driver of the weakness.

Of the two largest listed general insurers, Insurance Australia Group's ((IAG)) commercial trends in GWP growth were worse than Suncorp's ((SUN)), suffering weakness from volume losses in Australia. Nevertheless, JP Morgan notes industry profitability remains excellent. UBS expects the quest to restore credible growth at the natural level of market share will define the playing field for general insurance over the next few months. 

UBS notes the share prices of the domestic general insurers did not cave into slowing growth drivers over the reporting season, as investors chose to pay for inflated second half profits, yield and margin certainty. UBS admits underestimating the level of margin expansion in the second half of FY14 and the significance of yield and special dividends. Still, the broker is reluctant to embrace this paradigm altogether as a reason to invest.

Suncorp and IAG may not screen expensively but then, as UBS observes, general insurers do not re-rate much through the cycle. The significant event for these stocks is the turning point in underlying margin, which dictates forward earnings expectations. Furthermore, just to cloud the issue, price/earnings ratios can be deceiving at these cyclical turning points. The challenge, in the broker's view, comes down to picking the least overvalued of the stocks in the sector.

QBE Insurance ((QBE)) has been the test of an investor's patience, but UBS has a Buy rating as the stock looks less pricey than the other domestic general insurers. QBE still needs to prove its case but the balance sheet is recovering. Citi believes QBE's plans to deliver a capital surplus are realistic and provide a degree of comfort that the worst of the reserving issues are over. Valuation looks attractive and cost savings should assist a better FY15 result. Citi maintains QBE as its only Buy rating in the sector. The broker believes the expected turnaround and leverage to rising interest rates will outweigh the negative impact of continued pressure on premium rates.

AMP's ((AMP)) wealth protection issues appear to be stabilising and its favourable business mix, pricing and volume gains are expected to help profit margins in FY15. The company is also gaining traction with its Asian expansion strategy, while AMP Bank continues to add diversity. The main issue for Citi, and the reason the broker has downgraded to Neutral from a Buy rating, is valuation.

Dividend yield makes Suncorp the most topical of the general insurers and UBS believes efforts to improve capital efficiency are commendable, although the broker does not believe special dividends should not be capitalised. The broker considers it unlikely that Suncorp will achieve top line targets in FY15, while another special dividend is now priced into the stock. UBS downgraded Suncorp to Sell during the earnings season. Suncorp's capital returns and strong dividends should continue over the next three years and underpin the stock, in Citi's view. Even so, the broker considers Suncorp fully valued and retains a Neutral rating. FY14 was aided by favourable weather but Citi considers the target of 10% return on equity is a bit of a stretch, albeit achievable.

IAG's recent track record suggests to Citi its FY15 margin guidance of 13.5-15.5% is conservative. The company has reclaimed the title of the largest general insurer in Australia and is now at a stage where further acquisitive growth in either Australia or New Zealand is limited, for competition reasons. The key is how IAG delivers attractive insurance margins over the course of FY15. Citi suspects, in the absence of very favourable spread movements or high levels of reserve releases, it may require benign perils claims to match the FY14 dividend. UBS prefers this insurer's approach to guidance, as it can be quickly re-based to changing conditions compared with the aspirational approach taken by Suncorp.

Nib Holdings ((NHF)) looks overvalued to Citi and remains the broker's only Sell rating in the sector. The forthcoming IPO of Medibank Private could potentially lead to more rapid price discovery for nib. The stock is returning capital, but future special dividends appear set to be funded through re-leveraging. Given the operational issues and high multiples, Citi suspects share price risk is to the downside. Tower ((TWR)) is also set to return further capital and simplify its shareholder register. Citi believes the simplified business can now focus on the opportunity in the direct general insurance market in New Zealand, given its strong brand and relatively low market share compared with the larger two Australian-based insurers.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms