QBE Insurance has provided updated guidance, flagging a further downgrade to CY17 earnings. Significant hits have come from the company’s continued poor performance in emerging markets, a deterioration in previously guided catastrophe event costs, a lack of improvement in the US operations and some reserve strengthening.
QBE has significantly rebased its guidance for CY18, from the previously targeted 93% combined operating ratio (COR) to the current 95–97.5% level. We estimate 2017’s underlying COR at 96.9%, so it appears that for the first time in a while guidance is not assuming a step improvement in margins.
We see several positives for QBE, including:
- An upturn in commercial rates in most markets globally;
- Potential benefits from higher yields – we allow 0.6% over two years; and
- If the CEO has taken a conservative stance on reserves and profits in 2017 – as arguably may have been the case in Australia in 2016 – there could be upside to estimates.
Offsetting the positives, we note the following:
- Reserve releases may be drying up in some markets, based on recent trends from QBE, particularly in the US and Europe;
- Lenders’ mortgage insurance has been a significant driver of profit forecasts;
- We estimate QBE will need to increase its underlying margins by about 2% from 6.6% in 2017 to validate an upside thesis on valuation; and
- Reinsurance costs could rise eventually, offsetting some of the cycle benefits.
We have upgraded our recommendation to Accumulate from Hold to reflect the rebase of guidance, potential upside from the cycle, interest rates, and possible benefits to margins from a restructure. We have also raised our target price to $11.20 from $10.95. We place QBE behind Suncorp (SUN, Accumulate) in our stock preferences, but we note likely interest in the near term based on the themes flagged above.