Brokers Divided On QBE’s Outlook

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

QBE has downgraded its expected returns from emerging markets in 2017 and brokers are divided about the outlook.

-Larger-than-expected claims and lower premium rates beset the company in Asia
-Should the company shed more business?
-Has the sell-off provided a buying opportunity?
 

By Eva Brocklehurst

QBE Insurance ((QBE)) has endured larger-than-expected claims in emerging markets, particularly in Asia, while crop insurance issues in Ecuador and the Chile business in the four months prior to sale have damaged 2017 forecasts. Lower premium rates have also beset the company in Asia. Meanwhile, the Australasian business is performing to expectations.

The company provided few indications about the business outside of the downgrades in the update, and beyond the fact that original guidance has been maintained when excluding emerging markets. QBE has signalled a 100 basis points drag on insurance profit because of poor claims experiences in emerging markets. There is a lack of offsetting gains elsewhere, which highlights ongoing earnings pressure, in Credit Suisse's view.

The broker suggests that, when premium rates are going down, it is very likely that underwriting profit margins are also declining. Hence, while risk claims and increased frequency in other issues arise that justify the downgrades, the fact that premium rates have declined -5-10% in recent years suggests the margin was bound to fall anyway.

As a result, the broker contends the drag on margins is an underlying issue, and not one-off in nature as has been suggested by some investors. Credit Suisse is also disappointed that improvements elsewhere in the business could not offset the pressure on margins and believes that obtaining improved returns will be difficult in a falling premium rate environment.

The company is targeting a combined operating ratio of 93% in 2018 and above a 10% return on equity. As Morgan Stanley calculates, with around 10% of the book underperforming by around -10% and driving a -1% hit to the combined operating ratio, the margin for error in guidance is disappointing.

In a complex global business the broker would have hoped for some countering factor and outperformance elsewhere in the portfolio, or self-help options, to soften the downgrade. Singapore and Hong Kong hubs are competitive markets where the company has been targeting growth, yet the company is seeking remediation of the issues in this region and Morgan Stanley also takes heart in the fact that the Latin American losses are non-recurring.

The Australasian backdrop is improving, a trough seems to be forming in the US and the broker finds Europe has a better outlook following Lloyds withdrawing 10% of capital. Hence, the outlook for QBE is more encouraging and Morgan Stanley retains a Overweight rating.

Divestments?

The company's probable option, in Credit Suisse's opinion, is to shed more business and take pain in the expense ratio. While the stock may be closing in on fair value, with earnings risk to the downside, the broker retains an Underperform rating.

UBS also expects the obvious questions around the quality of the portfolio will be posed after this downgrade, amid speculation as to whether further divestments are required. The broker suggests the market will be nervous about the company's ability to cover all its bases across a complex group and deliver on profit guidance.

Regardless, with improving market conditions across Australasia and greater stability in other major jurisdictions, the broker is not changing its overweight view on either the company or the sector. Deutsche Bank is not overly concerned by the impact of the downgrade and believes earnings volatility can be managed through active risk limits and risk diversification, processes which the company is currently undertaking.

The broker believes the fall in the share price goes well beyond the temporary nature of the downgrade and the market's reaction reflects a loss of confidence in management being able to manage a very complex business. Deutsche Bank notes the company is yet to start its buying back of shares and would expect the program to provide some support to the stock in the short term.

Value?

QBE has flagged that, excluding the downgraded items, interim insurance margins are expected to be 8.5-9.5%. Ord Minnett has an insurance margin forecast of around 8% for 2017 and retains its previous concerns about optimistic guidance on underlying margins but also, now, has concerns over emerging markets.

Shaw and Partners, not one of the eight stockbrokers monitored daily on the FNArena database, believes, while the downgrade is disappointing, the problems should be fixed in the medium term. While acknowledging the update is likely to raise questions of execution risk and the company's track record, the broker maintains a Buy rating and $14.17 target.

Another downgrade has delivered a blow to sentiment that has undermined whatever credibility management has re-built, Citi asserts. Consequently, although the stock appears to still offer value, it remains hard for investors to buy with conviction in the near term. The broker downgrades to Neutral from Buy.

Morgans goes the other way, upgrading to Add from Hold. While acknowledging the bumps on the road to recovery are annoying, the broker believes the drivers of the downgrade are largely one-off in nature and the sell-off in the share price overdone. Underlying business trends are expected to improve following the remediation work that the company has done recently. The broker accepts the stock is not a clean story but believes it offers relative value.

Macquarie considers the downgrade largely abnormal in nature, yet concedes underlying guidance appears softer relative to bullish consensus expectations, and the market will likely use the update as an opportunity to revise forecasts.

The broker believes the medium-sized risk claims in Asia are the core of the problem and concurs that the pricing environment in Singapore and Hong Kong remains competitive. Macquarie believes a discount valuation to peers is justified, given ongoing earnings certainty, but suggests the stock now presents an attractive longer-term value opportunity.

The database has four Buy ratings, three Hold and two Sell. The consensus target is $12.86, signalling 9.1% in upside to the last share price. Targets range from $11.32 (Ord Minnett) to $13.80 (Macquarie). The dividend yield in present FX values on FY17 and FY18 forecasts is 4.9% and 6.0% respectively.
 

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