QBE’s Outlook Under Pressure

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

-Competitive pressure mounts
-Road to recovery taking longer
-Is a valuation premium justified?
 

By Eva Brocklehurst

Growth rates in insurance industry premiums continue to moderate and QBE Insurance ((QBE)) is actively reviewing exposures and selectively renewing accounts, in turn putting pressure on premium growth. The company acknowledged in its recent European and North American investor presentations that pressures in this regard were mounting. QBE reported a contraction of 10.1% in gross written premium (GWP) in the first half of 2014. Several brokers are now more cautious on the outlook and have put a return to premium growth on the back burner.

Macquarie does not expect GWP growth until 2016, and notes reinsurance rates are also under pressure while third party capital continues to move into the sector, expanding market capacity and putting pressure on prices. Morgan Stanley, too, highlights this feature. QBE Lloyds remains a market leader in Europe but disintermediation is driving investment in regional hubs and global underwriting capacity.

Morgan Stanley also observes the challenges in rebuilding the franchise are entrenched. As premium rates fall, the company appears to be hoping for a turnaround…but not until 2017. The broker notes the London market franchise is strong but it needs investment, while the road to recovery in the US may take even longer. In the US the rising expense ratio is hurting the insurer but QBE's distributor ties and the litigation that is under way are seen likely to inhibit any sale.

Against global peers, QBE has de-rated from parity to a 10% discount on Macquarie's index since September. This discount has occurred on only a small number of occasions over the past eight years. The de-rating has been driven by the underperformance in the share price. Are there any offsets? Cost cutting and increased investment risk could provide some mitigation. Macquarie is Neutral on the stock but this outlook includes a risk for a more positive investor response to the potential for higher interest rates and lower Australian currency.

In evaluating the key risks to QBE, Morgan Stanley is also mindful of the sensitivity to rising yields but concedes, given softening premium rates and record low yield environment, top line growth is difficult. To return to its glory days QBE needs insurance margins over 15% and hardening rates, as well as acquisitions in regions where it is underweight, in Morgan Stanley's view. Management is re-basing margins and reducing risk and the broker still considers the insurer's 14% long-run insurance margin remains achievable. Morgan Stanley's base case also incorporates abating risks around gearing and negative rating agency views. The broker suspects 2014 will be another year of transition but retains some leverage in its base case view to rising US yields and a falling Australian dollar.

Credit Suisse observes, too, that following some years of margin improvement QBE now faces softening premium rates and its tasks are getting tougher. The broker cautions against expecting a significant improvement on the 10% margin that is currently in place. GWP pressure is becoming more competition based and, hence, QBE is targeting selective growth. Credit Suisse is more confident that reserving issues are being addressed but notes this comes at a cost. The broker no longer believes QBE's returns justify a valuation premium to peers. If anything, a discount should be expected. Longer term, Credit Suisse finds the stock an interesting investment proposition. At present the broker retains a Neutral rating.

FNArena's database contains five Buy ratings and three Hold. The consensus target is $12.18, suggesting 5.8% upside to the last share price. Targets range from $11.60 to $13.00.
 

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