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The Wrap: Insurers, Airlines & Lending

Weekly Reports | Sep 07 2018

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Weekly Broker Wrap: general insurers; health insurers; domestic airlines; and lending.

-Absence of material margin benefit observed in commercial insurance
-Small natural peril claims the worst ever in second half of FY18 for IAG, SUN
-Capped pricing continues to be a potential risk for health insurers
-Focus for domestic airlines shifts to fuel costs
-Tightening of credit standards continues

 

By Eva Brocklehurst

General Insurers

Credit Suisse acknowledges that it may be hard for a number of investors to return with any confidence to AMP ((AMP)), or the insurance sector for that matter, ahead of the Royal Commission interim report.

Among the large insurers the broker's only Outperform rating is for AMP, while the broker has Neutral ratings for the other insurers as their valuations are getting full. Ahead of the hearings in coming weeks, Credit Suisse is happy to stay on the sidelines for now.

QBE Insurance ((QBE)) arguably has less risk from the Royal Commission than the domestic players but there is not enough evidence of a turnaround for the broker to become excited.

UBS finds the absence of any material margin benefit in commercial insurance is the most frustrating aspect of the current pricing cycle. All three general insurers have been challenged in this regard. The broker suggests, over the short term, motor portfolios should underpin margins.

The broker also believes only time will tell whether the shedding of some 8% of commercial market share to competitors will ultimately pay dividends. UBS is comfortable recommending investors sit tight with its Overweight call on general insurers.

The broker notes the traditional approach to running a commercial book through the cycle is to shed business through prolonged soft markets and grow as rates harden. The broker's analysis raises some questions around the the big three insurers' strategies and capabilities to manage this process.

UBS remains hopeful that commercial will be a significant source of wider margins in FY19. Although the stocks are in a tricky phase and more fairly valued the broker still believes Insurance Australia Group's ((IAG)) price/earnings ratio factors in high expectations and thus retains a Neutral rating, whereas positive earnings surprises do not appear priced in for Suncorp ((SUN)) and QBE, for which the broker has Buy ratings.

Credit Suisse noticed that small natural peril claims in the second half of FY18 for both Insurance Australia Group and Suncorp were the worst ever and offset a lack of large peril events. Suncorp's small hazard claims were around 50% above historical averages while Insurance Australia's were 65% above.

The insurers have increased their perils allowance for FY19, Suncorp by 4% and IAG by 6%, but exposures have also increased slightly, the broker points out. Credit Suisse considers Suncorp's natural hazard allowance is optimistically light and a base case year provides around -5% earnings downside risk to the company's net profit.

Nevertheless, the downside risk beyond FY19 is considered fairly well contained, as to get more than -10% earnings risk it would need to be an extreme year of claims. IAG's allowance offers 5-10% upside risk for earnings in FY19, if there are no events or only one large event, but the company is not immune from downside risk.

Credit Suisse suggests the downside earnings risk could be even larger for IAG if there are multiple events in each of the first and second halves of FY19.

Health Insurers

Macquarie observes both Medibank Private ((MPL)) and nib Holdings ((NHF)) have outperformed industry trends for claims growth. The broker suggests, in the midst of an election cycle and with broader affordability issues, the cost-push nature of the private health insurance industry could break down over the next few years.

This could pressure industry margins but the broker believes the listed funds are likely to weather the challenges better than their peers. Attractive distribution channels, hospital contracting and Medibank Private's rotation to younger customers all had an impact on FY18 and Macquarie expects these influences will continue in FY19.

The potential for capped pricing remains significant in terms of margin risks for the industry and the broker does not believe this is completely priced into consensus estimates. The main headwinds are the potential for a 2% cap to prices under a Labor government and ongoing participation issues.

Supportive aspects centre on softer average costs per procedure, a slowing in the growth of the number of hospital visits per person and number of days per visit. Prosthesis reform could also save the industry around $120m in FY19 and a further $70m in FY20.

Domestic Airlines

Domestic airlines reported the highest level of profits in FY18 in recent history. The focus for FY19 has shifted to the ability of each airline to deal with rising fuel costs and, in Citi's view, this is contingent on rational capacity growth prevailing in the Australian domestic market, again. The broker considers this still likely and, therefore, strong unit revenue growth and capacity utilisation is probable.

It only takes one to spoil any rationality, although Citi takes solace from stable fleets, the historical disconnect between planned and flown capacity and company commentary regarding discipline. Disciplined capacity growth is critical, in the broker's view, if both Qantas ((QAN)) and Virgin Australia ((VAH)) are to offset rising fuel costs.

Lending

UBS has surveyed 1008 Australians who took out a mortgage over the last year. Changes versus previous surveys were tested for statistical significance beyond the 95% confidence interval.

The broker found only 68% of respondents stated their mortgage application was completely factual and accurate. However, in the final quarter of the survey, April-July 2018, there was a statistically significant rise in those stating they were "completely factual and accurate".

There was also a statistically significant rise in respondents stating the application process was much more difficult in the final quarter versus previous experiences. From a customer experience perspective, UBS believes the survey provides compelling evidence that tightening of credit standards is accelerating, not peaking.

Banks appear more focused on responsible lending post the Royal Commission and the introduction of limits, as well as potential changes to negative gearing/capital gains tax.

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CHARTS

AMP IAG MPL NHF QAN QBE SUN

For more info SHARE ANALYSIS: AMP - AMP LIMITED

For more info SHARE ANALYSIS: IAG - INSURANCE AUSTRALIA GROUP LIMITED

For more info SHARE ANALYSIS: MPL - MEDIBANK PRIVATE LIMITED

For more info SHARE ANALYSIS: NHF - NIB HOLDINGS LIMITED

For more info SHARE ANALYSIS: QAN - QANTAS AIRWAYS LIMITED

For more info SHARE ANALYSIS: QBE - QBE INSURANCE GROUP LIMITED

For more info SHARE ANALYSIS: SUN - SUNCORP GROUP LIMITED