QBE Unfairly Treated For Modest Outlook

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

Brokers suggest the market has overreacted to QBE's update, given the progress made in 2018 and the cost reductions outlined for the next three years.

-Trajectory of business improvements has been extended
-More conventional reinsurance program now installed
-Unclear if restructuring costs will affect the dividend
 

By Eva Brocklehurst

QBE Insurance ((QBE)) disappointed the market with its update on its 2019 reinsurance and operating outlook, given the slump in the shares, although brokers are puzzled as to why. Guidance for 2018 is in line with expectations while a 3-year efficiency program has been outlined and more traditional reinsurance has been disclosed.

Morgans contends the recent fall in the share price is unjustified given the solid progress in 2018 and the latest initiatives, upgrading to Add from Hold.  The positives the broker points to, include significant detail on cost reductions, although the quantum, US$130m, is lower than similar programs being conducted by peers.

The update was actually more about "business as usual" UBS asserts, with a slightly larger drag on 2019 expectations versus prior forecasts. Macquarie points out the trajectory of business improvement has been extended versus prior expectations, while premium rate improvements, cost reductions and de-risking underpin the investment thesis.

Ultimate cost savings and reinsurance are largely in line, although some differences to timing mean Credit Suisse adjusts estimates down by -2.5% in 2019, as a result of restructuring costs being spread over two years. Offsetting this is a -4% downgrade to 2020 estimates as some one-off costs are pushed into that year.

The lack of a combined operating ratio target for the outer years may be interpreted as a lack of confidence in the turnaround story, the broker suspects. The market also appeared disappointed with the absolute level of cost savings announced by QBE.

The main negative, in Citi's view, was the one-off restructuring costs of US$95m, particularly as the efficiency program supports rather than enhances prior forecasts. The US$130m in efficiencies targeted over three years is slightly better than expected. The company announced US$200m in gross cost savings but noted that cost inflation at around 4% over the next three years will offset some of these savings.

Morgan Stanley is more confident the company will meet expectations for 2018. Strong execution is supported by improving fundamentals, although the broker acknowledges market volatility is increasing. As a result of market volatility, investment income is now expected to be at the mid point of the 2.25-2.75% guidance range, down from the "top end" guided in November.

Reinsurance

QBE has restructured its reinsurance program for 2019 moving to a more conventional structure versus past cover that locked in claims costs at around US$1.2bn. While the reinsurance costs will fall, a lack of aggregate large risk protection will mean the catastrophe and large risk claim budget rises to US$1.4bn.

The new reinsurance program increases the amount of risk taken on the balance sheet which has potential, Citi suggests, to cause greater volatility in the results. Even so, the broker believes the risk is low for disappointment in 2018. Morgans believes a more flexible reinsurance program makes sense, given QBE has streamlined its portfolio and reduced its risk exposures.

Lack Of Targets

Credit Suisse is pleased with the decision not to provide some aspirational three-year profitability targets, which it believes have historically impressed the market at the time but led to disappointment in the years that followed.

For a stock where the outlook is heavily reliant on guidance, the lack of out a year targets has meant many have questioned future profitability levels. The broker asserts QBE has taken a more realistic and, potentially, conservative approach.

Credit Suisse believes consensus estimates are often too high and, when inflated expectations are not realised, management tends to be blamed. The broker had assumed that, after a decade of disappointment, the buy-side would be looking for more realistic numbers. However, it appears the share price remains correlated to sell-side forecasts more so than the broker envisaged.

The company has outlined modest and selective premium growth, expecting an improvement to 14% in the expense ratio by 2021. Should the current premium rate increases continue this could be bettered, in Credit Suisse's view. Nevertheless, the broker concedes it would be too optimistic for the company to assume that the current recovery in global premium rates will continue over the next three years.

Citi believes QBE still has much to prove but appears to be on track.  Expense savings and risk losses were slightly higher than allowed for, but the outlook is considered conservative if outlined savings can be achieved.

Moreover, upside to the share price is possible over the medium term if QBE can move towards a forecast combined operating ratio of 93.4%, expected to be achieved around 2021. The company has confirmed a better result is expected in 2019 versus 2018.

Most of the savings appeared to come from what Citi describes as low hanging fruit ,including reducing the use of consultants, cutting travel costs through greater use of videoconferencing and rationalising office sites.

One third of cost savings are to come from North America where the sale of the personal lines business will significantly reduce operating complexity. The broker points out it is unclear if restructuring costs will affect the dividend, with the board yet to make a decision.

With the sale of Puerto Rico, Indonesia and Philippines the portfolio review has now concluded. QBE expects to lose around US$100m of gross written premium as a result of the divestments but also notes these businesses had a disproportionately high catastrophe risk exposure.

FNArena's database shows seven Buy ratings and one Hold (Deutsche Bank, yet to comment on the update). The consensus target is $12.12, signalling 21.7% upside to the last share price. The dividend yield on 2018 and 2019 forecasts at present FX values is 6.3% and 7.4% respectively.

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