Australia | Jul 03 2013
-Potential upside to savings
-Transition to Manila going smoothly
-Premium rate increases to taper off
By Eva Brocklehurst
QBE Insurance ((QBE)) has added detail to the transformation strategy currently underway. Brokers are upbeat on the company's progress and encouraged by the strengthening balance sheet as well as optimistic about further upside to savings. Catastrophes have been relatively benign so far this year and reserves appear roomy.
QBE was affected by three material catastrophes in the first half including Cyclone Oswald, the Oklahoma tornadoes and the European floods (which were worse than 2002). Individual risk losses included a landslip at a copper mine in Utah and the collapse of a railway line in the UK.
The company has conservatively forecast that initiatives should deliver expense savings of at least $250 million by the end of 2015. The company advised of some added benefits to the claims line of around $90m. Most brokers had incorporated the savings already into forecasts but were keen to get any additional information. The transformation plan is on track and forecast implementation costs have fallen by $20m to $310m.
Key to the update was the transition to the Global Shared Services Centre (GSSC) in Manila. Australian operations are on track for completion by the first quarter of 2014. North America will follow, running from the fourth quarter this year to the second quarter 2015 and Europe will run from the second quarter 2014 to the second quarter 2015. Savings are expected to be split one third to Australia, one half to North America and the remainder to Europe. Morgan Stanley notes Australia seems to be running ahead of plan, North America is commencing execution earlier than expected and targeted savings in Europe appear conservative.
Manila was selected as the location because of a highly educated workforce, cost competitiveness and reliable infrastructure. The company assured brokers the process was being staged carefully and larger, more complex claims would continue to be managed locally. High volume operations are being sent to Manila while in-depth operations will stay in Australia, so senior underwriters can spend more time on value-adding work. Complex claims over US$100,000 will remain in Australia.
Some of the company's global competitors have already moved to access low-cost labour via offshore operations. QBE has the advantage in the Philipppines, in Deutsche Bank's observation, because of employee preferences for Australian companies, shift hours being more favourable. This suggests the company could leverage offshore operations more so than peers, providing some structural operational advantages which position QBE more favourably on the cost curve.
Premium rates have been relatively strong in the first half, outside of the UK and Europe, but the company expects this to taper off in the second half, which makes the top line a little more challenging. Capacity is placing pressure on premiums but, as these were up more than 5% in the first half, QBE is confident on delivering on guidance. Morgan Stanley highlights the preference for margin over top line growth as a positive factor. Credit Suisse does warn that comparing QBE to some peers is dangerous, particularly locals. The business mix is different to most listed players. The broker avoids the temptation to benchmark QBE's expenses against some of the larger peers and believes insurance margin and return on equity are the best indicators of success.
In terms of the first half, investment yield is expected to be in line with guidance of around 2.25% and the sustained Australian dollar weakness is considered positive for the Australian earnings although adversely affecting US$ reported premium and earnings. It has been a relatively quiet period for catastrophe incidents but the bigger risk resides in the second half. US hurricanes are the main risk for QBE, while US crop exposure is also skewed to the second half. Other features of the update were within expectations. The dividend is expected to be weighted 40% to the interim and 60% to the final payment.
Reinsurance rates have softened. Morgan Stanley notes these rates are down around 10% globally and as much as 15-20% for Texas wind events and Florida catastrophes, but then QBE does not write much business in these areas. As a net acquirer of reinsurance this is viewed positively as the January 1 renewal approaches. QBE writes a US$1.4 billion inwards reinsurance book against buying US$2.5bn in reinsurance cover.
QBE will look at selling non-core assets by the end of the year and there are potential proceeds around $80 million. So far it has confirmed the sale of Australian broker agencies (NCIB) and Invivo to Steadfast, provided the IPO is successful, and plans to offload a majority stake in QBE Macedonia.
Overall, brokers are firm but conservative on the ratings front. On the FNArena database there are six Hold and two Buy ratings. There are no Sell ratings. The consensus target price is $16.06, suggesting 2.1% upside to the last share price. The target price has risen from $14.82 a week ago. Target prices range from $13.55 (JP Morgan) to $17.80 (Deutsche Bank).
Deutsche Bank rates the stock a Buy. This is supported by earnings and savings being on track and an improving macro backdrop, as well as the confirmation the turnaround is progressing well. The key upside risk is the additional cost savings. The broker notes consensus factors in only 50% of the implied 220 basis points of ITR margin benefit. In addition, the potential for claims procurement savings has now been quantified ($90m) which could lift profits a further 4% if not reinvested. This should benefit underlying margins by up to 1.9% by FY16, in the broker's view.
Macquarie has hailed the rapid progress being made and expects the cost cutting program will result in consensus earnings upgrades, retaining an Outperform rating. The broker also expects upside to the savings potential with scope to remove costs from Europe as well as North America and Australia. Macquarie notes no IT benefits have been factored into the savings as yet but they were identified, such as labour cost reductions and processing efficiencies. QBE is Credit Suisse's preferred pick in the sector, having addressed debt issues and with management lining the business up for future growth.
For UBS the overhaul has been long overdue and there is an element of catch-up to other global insurers in this respect. Nevertheless, the company is considered to be executing well. Along the same lines, CIMB considers the insurer is on track, but cautions that the recent rally, based largely on external factors, means the share price now looks to be incorporating much of the potential upside.
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.
