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Stock: QBE Insurance Group Limited

Stock code: QBE 

Share Price: $17.17 (as at Friday 11th March, 2011)

Broker buys: 

Patersons (28/2/2011, share price was $18.14 that day)

Shadforths (21/2/2011, share price was $18.90 that day)

Broker holds:

Alto Capital (7/2/2011, share price was $18.40 that day)

Chart: Share price over the year to 11/03/2011 versus ASX200 (XJO) 

You can’t blame QBE shareholders for feeling that mother nature is against them. In February QBE warned that insurers in Australia and New Zealand will find it tougher to buy reinsurance, after a series of natural disasters pushed the company’s full-year profit down 17%. QBE Insurance chief executive Frank O’Halloran recently told analysts that some of the world’s biggest reinsurers had taken a financial ‘hammering’ from payouts linked to floods, hailstorms and now earthquakes.  

Despite the less than sanguine comments from O’Halloran, QBE Chairman Belinda Hutchinson said: “This was a very positive result given the difficult global economic conditions…Our outlook is positive, with expected net earned premium growth of 22 percent to 25 percent in 2011 from acquisitions already announced and an expectation that insurance profit will grow by at least a similar percentage.’   

Investors are still trying to figure out how much bad news is already priced into QBE shares. And is the recent price decline an opportunity to pick up QBE for a bargain?

Company Description

The QBE Insurance Group is Australia’s largest general insurance and reinsurance group. QBE was founded in 1886 by James Burns and Robert Philip. QBE is one of the top 25 insurers and reinsurers worldwide and operates in all key insurance markets with offices in 47 countries and over 13,000 employees worldwide.

Strategy

QBE’s current growth strategy is based on organic growth from existing diversified operations supplemented by acquisitions. QBE has made over 130 acquisitions over the past 25 years and currently operates in 47 countries.  In 2010, QBE made seven acquisitions in North America, Latin America and Europe adding US$1,825 million of annualised gross premiums.  The total cost of these acquisitions will be around US$1.4 billion, funded mainly from existing resources and additional borrowings.  Since year end, QBE has announced the acquisition of the Australian operations of CUNA Mutual and agreed to buy Bank of America’s Balboa Insurance portfolio for more than $700 million to bolster its U.S. operations. These acquisitions are expected to be accretive to the bottom line in 2011 and beyond.  

Earnings

QBE reported a 16 percent drop in full-year net profit, hurt by lower investment yields and higher catastrophe claims.  Net income in 2010 dropped to $1.28 billion from $1.53 billion a year earlier.

The insurance profit margin, a widely watched underlying profitability measure narrowed to 15 percent last year from 17 percent. But QBE expects net earned premiums – the company’s key revenue measure – will grow between 22 percent and 25 percent in 2011 aided by recent acquisitions.  Net earned premium rose by 20% in 2010 to US$11.36 billion from US$9.45 billion the previous year.  O’Halloran told analysts there is “an expectation that insurance profit will grow by at least a similar percentage.”

In the latest company announcement management revealed that payouts linked to disasters have so far totalled $385 million, including a $175 million cost relating to the New Zealand earthquake. O’Halloran stated that QBE is insulated from any price (re-insurance) rises, having locked in a three-year deal with reinsurers last year.  QBE has budgeted as much as $1.6 billion for natural disasters for 2011.

Balance Sheet

QBE balance sheet is strong as reflected by a capital adequacy multiple at 1.6 times regulatory requirements and US$2.7bn in excess capital of the minimum capital requirement of $4.3 billion. The QBE board considers the excess to be healthy given the low debt levels and the company’s proven ability to raise funds. Balance sheet gearing ended the year at 31.5 percent compared with 29.1 percent the prior year.

QBE management was able to take advantage of the current low interest rates in the global markets and lock in lower cost longer-term debt. The weighted average cost of borrowings was reduced to 5.3 percent from 6.8 percent. This refinancing was done to provide additional funds to support growth while reducing borrowing costs. The company has a policy that borrowings should not exceed 50 percent of shareholders’ funds.

Probability of adequacy of outstanding claims for QBE was 88.1 percent above APRA’s 75 percent minimum requirement and QBE continues to earn underwriting surpluses despite competitive pressures. Group combined operating ratio has been below 90 percent for five consecutive years.

Standard & Poor confirmed it’s A+ rating for QBE’s major insurance entities or an equivalent A credit rating for the parent company.

Technical Picture

 

QBE has been trading in a nice bullish channel for the last three months.  Bullish crossover of moving averages may suggest to technicians that the short downward correction for QBE is coming to an end.  RSI reaching oversold area increases the probability for a reversal to the top of the channel.  A swing low here could confirm  that the uptrend is still intact as QBE makes a higher low following its recent higher high.  A new swing low would imply that the current upward trend is in jeopardy.

Analysts

The 12-month price target for QBE by 8 analysts covering the company was 19.54 with a high forecast of 22.01 and low of 18.50.

Mark Goulopoulos of Patersons Securities has a buy recommendation on QBE. He recently commented that: “A recent market update contained positive developments for QBE. Cost estimates of the recent catastrophes in Australia were well within market expectations. Guidance for 2010 earning was reaffirmed, the acquisition of the Balboa insurance portfolio was announced and strong guidance was provided for the 2011 year.”

Alto Capital’s Carey Smith said: “Global QBE is among the finest managed and profitable insurance groups in the industry. Investors are regaining confidence in company management after several profit downgrades. The recent floods in Australia will only have a minimal impact on profitability.”

Valuation  

Taking in account management expectations that EPS will be between 1.47 and 1.67 based on growth rates of 25 percent to 40 percent, and using a PE multiple of 15, QBE shares are valued at between $22 and $25.  This PE multiple was based on QBE’s long term growth rates, conservative management team and adjusting for the appropriate risk facing the company.  Future growth rates will be driven by underwriting profit and a recovery in investment income on premiums.  Management expects net earned premium to grow in excess of 20 percent and net profit growth of 40 percent for 2011.

Conclusion

Recent price action may suggest that the market is lacks confidence in QBE’s ability to meet the reaffirmed guidance announced by the company.  In the past 12 months, QBE’s shares have fallen 15 per cent compared with a 5 per cent rise in the overall market. 

Investors who can handle short-term market volatility, however, may want to take a closer look at QBE. When you factor in QBE’s quality balance sheet, strong management and current valuation, some brokers say that QBE is a compelling investment at current market levels.  The current negative sentiment in the market, therefore, could be viewed as a welcome opportunity to pick up shares at a reasonable valuation.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.