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Treasure Chest: Might QBE Not Disappoint This Time?

Treasure Chest | Jul 20 2018

Citi upgrades QBE Insurance to Buy amidst much discussion of restructuring and the need to address reinsurance in January.

-Plan to reduce costs
-Reinsurance renewal looming
-Chance of short term share price upside


By Greg Peel

2018 is proving a fairly benign year on the catastrophe front for QBE Insurance ((QBE)) following what was a costly 2017. Come January, the insurer faces a major reinsurance renewal and has to make an important decision.

A renewal will come at a higher cost. The alternative is to take the risk onto its own books, but this would imply higher earnings volatility. Either choice will dampen market sentiment on the stock, Credit Suisse believes, unless there is a clear improvement in margins.

Cost reduction plans are aimed at increasing margins but these would be undermined by a higher reinsurance cost. A more favourable premium rate environment would certainly help, Credit Suisse notes, but here the outlook is uncertain.

The broker retains a Neutral rating.

Macquarie retains Outperform, suggesting there is scope for QBE to increase its risk exposure come reinsurance renewal time given concerns about the longevity of insurance-linked securities as a capital source have now been allayed.

Citi believes QBE will unlikely be able to renew its reinsurance and also warns of increased earnings volatility as a result. The broker sees a risk that simply redeploying the savings from not renewing will be insufficient for the desired level of reinsurance cover. But at least for now, reinsurance pricing seems relatively stable, Citi notes, which should help the company formulate its new reinsurance policy.

On Citi’s analysis, QBE’s share price is now at a level that upside should follow when the company reports earnings if the company’s first half combined operating ratio is reasonable and in line with the broker’s forecast. Some improvement in Asia and North America is likely due to business disposals, the first half appears to have been benign for catastrophes and there have been some premium rate rises, hence Citi gives upside a fair chance.

It will only be a short term response, nonetheless, with execution on the company’s restructure plans paramount in the longer term, Citi warns. The broker is a little more confident in its revised forecast for FY19 and beyond and believes the business could deliver a strong combined operating ratio by FY21, which would lead to meaningful share price upside.

But given QBE has disappointed so many times in the past, Citi reinforces that execution remains key.

The broker has nevertheless given QBE the benefit of the doubt in upgrading to a Buy rating, for now.

This brings the number of buy-raters in the FNArena broker database to five, with three Holds. The consensus target price is $11.10, suggesting 11.3% upside.

QBE reports on August 16.

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