The Wrap: Insurers, IP, China And Gas

Weekly Reports | Mar 17 2017

Weekly Broker Wrap: Insurers and Youi; value in IP services; equity strategy: China outlook; and the issue of an east coast gas shortfall.

-Domestic majors deliver better GWP outcomes in first half versus Youi
-IP services companies seen offering compelling value
-Deutsche Bank moves to overweight on banks and miners
-Solid outlook in China, Improved seasonal demand expected
-Could a national oil company work for Australia?


By Eva Brocklehurst


UBS has taken a close look at Youi's first half result, the fastest growing and most visible challenger brand in the insurance sector to date. On the broker's estimates, gross written premium (GWP) only grew by 0.5% and, for the first time since Youi commenced operations in 2009, the domestic majors actually delivered better outcomes.

UBS does not believe other challenger brands have slowed to the same degree and Youi's brand proposition remains intact. Nevertheless, Insurance Australia Group ((IAG)) and Suncorp ((SUN)) are expected to face an easier operating environment over the medium term.

Macquarie believes Youi is still growing faster than the market, noting the first half results follow a poor result in the prior half for GWP. The company is also, as noted, addressing a couple of specific issues such as customer confidence in its brand and distribution constraints. While slower churn in the market is a headwind for challenger brands the company believes this will abate.

A lack of natural catastrophe events have resulted in a soft pricing environment and consumers are not shopping around for lower premiums. Macquarie believes the major challenger brands will continue to increase their market share and impact on the overall profitability of the incumbents.

UBS believes the worst of the cyclical margin squeeze since FY14/15 is now behind the sector. As in the past, the broker suspects recovery is likely to be underestimated. Commercial profitability is turning around earlier than expected. Suncorp's personal lines are running better than previously believed although New Zealand could become worse before it gets better.

Personal lines margins are expected to stabilise in the industry, if not rise in 2017, as insurers respond to claims inflation with containment measures. The broker believes there is a case to own all the insurers but retains a preference for Suncorp (Buy) over IAG (Neutral).

IP Services

Bell Potter believes intellectual property services offer compelling value and are now trading materially below the market. The three companies IPH Ltd ((IPH)), QANTM IP ((QIP)) and Xenith IP ((XIP)), which form the ASX listed sector, are all trading at a discount to market price/earnings for FY17 to the tune of -1%, -11% and -27% respectively. While agreeing with the relative ratio ranking between the three, the broker believes the sector as a whole is materially undervalued.

The broker accepts there was merit for a de-rating of the sector, given stretched valuations a year ago. Yet, more recently the sector experienced a further downgrade with a number of company-specific issues weighing, such as IPH's slower growth in Asia, seasonality in regard to QANTM and investment by Xenith to support integration.

Bell Potter believes this is an attractive buying opportunity and prefers QANTM and IPH. Core fundamentals that are underpinning a positive outlook include diverse clients, relatively high revenue visibility, minimal work-in-progress, 90-100% cash flow conversion and solid balance sheets.

Equity Strategy

Global equities may be vulnerable to a dip, Deutsche Bank suggests. The broker notes it has been a long time since the S&P500 dropped much and the US Federal Reserve rate hikes pose a risk. Beyond a dip, Australian equities appear well positioned. Earnings continue to be upgraded and the average price/earnings ratio of around 16 remains in line with the fair value model.

The main concern is that share prices of major miners may struggle when the iron ore price eventually falls, although the broker's analysis suggests the relevant stocks have already priced in a fall and share prices look low relative to firm Chinese growth.

Deutsche Bank moves to overweight on banks as well and asks the question whether it can work to be positioned in both of these heavyweight sectors. The answer is, yes, as it is not all that rare for both sectors to outperform and valuations are low versus the industrials.

The broker has cut back exposure to yield stocks as they have been in a holding pattern in recent months and now look vulnerable with Fed rate hikes finally on the way. Meanwhile, value stocks are attractive, with financials in this bracket.

Domestic conditions appear soft as, while nominal GDP growth is back to average, it is lacklustre relative to the move in commodity prices. The broker observes miners are not sharing the gains around, with revenues being up but expenditure on capital investment and other costs at a decade low. Meanwhile, the consumers spending impulse has softened. The housing cycle is still rolling on and this should benefit select stocks.

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