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Poor US Crop Pegs QBE Profitability

Australia | Dec 19 2019

QBE Insurance expects reduced profitability in 2019 as a result of frost damage impacting on the North American crop in the second half.

-Most brokers assume guidance is conservative and impact a one-off
-Is it too early to consider maiden 2020 guidance conservative?
-Valuation upside diminished with recent rally in the stock


By Eva Brocklehurst

The vagaries of the weather, frost this time, have affected US crop insurance in 2019 and, as a result, QBE Insurance ((QBE)) expects to report a weaker outcome for the year. Late-planted crops, delayed by a wet spring, were more exposed to early snow, frost and hail.

The company's combined operating ratio (COR) for 2019, which compares costs relative to premiums, is now expected at around 107-109%, ahead of the 90% allowance in prior guidance. The 2019 net investment return is still expected to be at the top end of guidance of 3-3.5%.

Morgans, while disappointed, believes the downgrade is at the minor end of the spectrum, as a difficult season had been well flagged. On face value, it would appear QBE would have delivered a 2019 result that was comfortably inside guidance when stripping out the particular impact from the North American crop.

Macquarie, too, stresses this is a one-off, and a poor performance in 2019 will be somewhat countered by lower reinsurance costs in 2020. The broker believes short-term risks have now been removed and assesses the underlying business is improving. However, inflation bears watching closely, related to casualty and specialty risks in the US and UK.

Ord Minnett reduces forecasts for earnings per share by -10% for 2019 as a result of the update. After adjusting for the impact of the crop segment on the 2019 estimates, this suggests only slight margin improvement into 2020. The broker suspects this view could be conservative, taking into account the strength of the premium cycle and the lack of claims inflation in the US or UK.

Morgan Stanley assesses the guidance implies downside risk to its 2020 net profit estimates of around -5% at the top of the range and -15% at the mid point and acknowledges this is disappointing because of strong pricing commentary.

The market appears surprised by the level of deterioration in the loss ratio in the second half but Credit Suisse has highlighted previously that QBE does not disclose reinsurance on crop and urges investors to pressure the company, so the risk can be better assessed from such an important line of business.

The broker also bemoans the fact that investors will again assume guidance is conservative, emphasising that, despite a late-term miss in 2019, maiden 2020 COR guidance of 93.5-95.5% is already being described as conservative and on track to be beaten.

Credit Suisse supports what management is doing and acknowledges the operating environment is continuing to work in the company's favour. The real issue is the constantly elevated consensus earnings forecasts that give the perception that the stock is cheaper than it really is.

However, with the downgrades for 2019 and 2020 done and dusted, and the stock underperforming the market by around -10% over the last nine months, Credit Suisse acknowledges some valuation appeal is developing. A Neutral rating is maintained as the broker would like additional detail on the deterioration in second half.

This does not perturb UBS which, while reducing 2019 estimates by -17%, maintains its outer year forecasts, Buy rating and outlook. The broker considers its view supported by the improving premium rate momentum and management commentary around US reserve adequacy.

US crop protection still remains attractive and the 2019 experience is expected to have no bearing on 2020. UBS believes QBE can deliver in the upper half of its returns guidance range for 2020.

Morgans agrees management is executing well and improving the overall business performance but, considering the rally in the share price recently, finds less upside at current levels, downgrading to Hold from Add.

Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, asserts the market is right to look past the higher North American crop claims and focus on a better COR outcome in 2020. Still, the broker acknowledges the stellar run up in the share price and believes a Hold rating is justified, with a target of $13.60, based on valuation alone.

There are four Buy and three Hold ratings on the database. The consensus target is $13.07, signalling -0.5% downside to the last share price. Targets range from $12.37 (Morgans) to $14.00 (Morgan Stanley). The dividend yield on 2019 and 2020 forecasts is 5.0% and 6.2% respectively.

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