QBE To Return More Capital?

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

-Emerging markets contributing more
-Attractive capital management potential
-Efficiency gains needed to insulate margins
 

By Eva Brocklehurst

QBE Insurance ((QBE)) has outlined its growth and cost reduction plans to 2018. The company has provided a gross written premium (GWP) target growth rate of 3% with an 11% insurance margin and expense target of $300m.

The insurer is considerably more organised and efficient now, UBS contends. The company intends returning CTP (green slips) to profit and defending its exposure to lenders mortgage insurance. Europe has been re-established as the most consistent performer, with the business selectively growing.

Emerging markets, improved retention and five specific growth areas are expected to add 1% per annum to achieve the GWP targets. Achieving the targets should allow the insurer to reach 10% per annum net profit growth into 2018.

A $50-100m underwriting improvement and claims savings of $200m are incremental to UBS estimates. Otherwise, the broker found the further details on how the targets are to be delivered are aligning with its forecasts.

On capital, the company indicates it does not need as much surplus, with its base now highly resilient to realistic one-in-20 year disasters. Management was not specific about its plans but UBS believe capital management could emerge as an important part of the investment thesis if targets are delivered.

QBE assumes no increase in market pricing or no change to interest rates in its forecasts and Macquarie notes GWP growth assumptions are to be achieved via emerging markets contributions, which have provided 100 basis points in the year to date. The company is also targeting a cumulative cash remittance of $2.5bn over 2016-18, with a dividend pay-out ratio of up to 65%.

The guidance, combined with the emergence of the capital management potential, suggests upside to an already attractive outlook in Deutsche Bank's view. The FY18 outlook implies an 11% margin, which is in line with the broker's estimates, while factors such as higher risk-free rates or reserve releases could boost margins to 12%, equating to 10% profit upside.

Furthermore, with the balance sheet already strongly capitalised and GWP growth of 3% expected, the broker highlights the capital management potential from FY17, even allowing for the lift in the dividend pay-out ratio. Buy-backs are estimated to boost earnings by 6% by FY20, returns on equity by 90 basis points and long-term discounted cash flow by 11%.

Morgans observes management would not be drawn on the potential for special dividends, rather alluding to significant capital flexibility. Management's confidence in the improvement in the North American business has increased while emerging markets are seen as key growth areas.

Morgans also finds the earnings profile attractive and considers the leverage to an improving insurance pricing cycle, or a rise in bond yields, has increased significantly, continuing to believe the stock is inexpensive.

The targets are aspirations. They are not locked in, Credit Suisse warns. There are many moving parts that need to work over the next three years. The broker lauds the company for providing such a level of detail around assumptions but retains a more cautious view on premium rates and investment income. QBE is depending on improvement in both to achieve its growth ambitions.

The broker does not believe the targets are easily achieved and, indeed, the presentation highlighted that around US$500m in costs are needed to come out of the business just to stand still over the next three years. The broker supports QBE's actions but wants to witness more favourable signs in the premium and investment markets in order to have a more positive view.

The new targets for growth are impressive, but Morgan Stanley notes they come with increased earnings volatility. The broker also believes it is too early to return capital and the soft operating environment will make it essential QBE delivers its efficiency gains to insulate margins from pricing pressure. Where it could be mistaken, Morgan Stanley acknowledges, is if the company fast tracks a capital release by selling or reinsuring legacy run-off books.

Ord Minnett is a little sceptical too, retaining a Lighten rating. After de-risking its book via capital raising and increasing reinsurance, the company is now intent on hiking investment risk to boost margins.

The broker is cautious about the expense and claims savings which are planned to offset the cycle, as the returns so far on initiatives in this area have not been witnessed by shareholders and much of it is suspected to be reinvested or competed away. While considering it difficult for insurers to make underwriting gains in a soft cycle, the broker does factor into the forecasts the company’s risking up of its investments.

FNArena's database shows five Buy ratings, two Hold and one Sell (Ord Minnett) for QBE. The consensus target is $12.51, suggesting 5.6% upside to the last share price. This compares with $12.35 ahead of the update. Targets range from $11.45 (Credit Suisse) to $13.70 (Deutsche Bank).
 

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