Pricing power in spades
Insurer QBE (ASX:QBE) recently provided an update, noting the upward pressure on catastrophe costs. Despite this, the hardening premium cycle and improving investment yields are providing firm support. Indeed, QBE (ASX:QBE) held steady on full-year earnings and so-called combined operating ratio guidance – a key insurance industry metric.
Although there were a couple of unwelcome elements, the recent update, ahead of 1H23 results, does not diminish our positive view. QBE shares have been solid gainers over the past year, yet the valuation remains moderate. In our view, there is scope for further upside in the coming quarters/years via a combination of multiple expansions (we foresee a discount to peers narrowing) and earnings growth. We rate the stock a buy.
To recap our investment thesis, QBE (ASX:QBE) has been demonstrating admirable pricing power, lifting premiums at a pace above that of elevated levels of inflation. Despite premium rates rising strongly, demand has been robust (i.e., inelastic demand). This is a great business attribute to have at any time, but particularly valuable during periods of elevated inflation. QBE is showing it has pricing power in spades during this ‘hardening cycle’ in the insurance game. For various reasons (discussed in prior coverage) we think this hardening cycle has much longer to run.
Meanwhile, after years of facing headwinds for investment returns, the backdrop has switched to a tailwind for looming returns on the insurer’s vast ‘float.’ The exit running yield (an indicator of returns) was firmly higher at the end of the half year. Effectively, the top-line outlook for QBE Insurance is attractive and set to remain so, while many other sectors and most companies are facing increasingly cloudy weather on that front. This could see more fund flows switch to insurers going forward, especially from banks. The lower correlation of the insurers with recessions is appealing.
 We like the simplification of the business QBE implemented in prior years, with scope for more on this front. Increasingly sophistication in modelling risks should benefit the company and peers going forward. CEO Andrew Horton has a strong track record, and we are content with his stewardship. Key risks for QBE and its peers remain catastrophe costs and climate change, however, they are only serving to ‘harden’ the premium cycle further. The balance sheet is strong. Meanwhile, input cost inflation is set to moderate and combined with the strong top-line growth, we are expecting underlying margins to expand going forward.
We maintain our buy rating on QBE (ASX:QBE).
Turning to the charts, QBE (ASX:QBE) shares continue to trade in an upward-trending channel which started in mid-February after the release of FY22 results. The moving averages (50-day [red], 200-day [green]) also confirm the continued uptrend. Most recent price action, however, indicates a potential stall at the multi-year resistance zone around ~16.
Update – in US$ unless otherwise noted.
Last week QBE (ASX:QBE) provided an update ahead of 1H23 results, due for release next month. The insurer flagged several items expected to impact the group’s financials, including a blowout in catastrophe costs thanks to a series of North American storms. The key takeaways though were that QBE reiterated prior full-year earnings forecasts, strong premium growth and a combined operating ratio (COR) of approximately 94.5%. The COR outlook includes a revised, larger FY23 catastrophe budget of $1.33 billion. Group constant currency gross written premium growth for the year is pegged at circa 10%.
Retaining full-year guidance for the key metrics implies the underlying performance is likely to be significantly better than the market was earlier anticipating. This bodes well for the medium-term earnings outlook.
Regarding the specifics of the update and QBE (ASX:QBE) now anticipates 1H23 net catastrophe costs to come in around the $700 million mark, above the level outlined back in May Additionally, there was more bad news from prior year adverse developments. Another $40 million related to prior crop damage will come on top of the previously flagged $140 million in catastrophe claims announced in May. The 1H23 results are also set to include an adverse net impact of $30 million related to asset liability management activities. Overall, the additional losses were relatively small scale compared to some of the blowouts we have seen in the past.
Meanwhile, there were some bullish elements to the update as well. QBE expects 1H23 investment income of around $660 million. This includes a $50 million bump from changes in credit spreads. Still, the higher interest rates supported core fixed-income returns. The 1H23 exit running yield increased substantially to approximately 4.9% at the end of 1H23. This is a positive harbinger for future investment income.
As we noted in prior coverage, in 1Q23 the exit running yield had increased to 4.2% from 4.1% at the end of December 2022. That backdrop helped lead to a strong investment result in 1Q23, and we expect this to continue to be a tailwind throughout FY23.
Source: QBE (ASX:QBE)
Meanwhile, QBE continues to ride a wave of growth in the hardening insurance cycle. Gross written premiums grew an impressive 13% in constant currency terms. Accordingly, 1H23 gross written premium revenue is anticipated to be $12.8 billion, up 10%.
Ultimately, that QBE retained FY23 targets were retained despite some hits on the catastrophe side was a major positive. This signalled a strong underlying performance.
We continue to rate QBE (ASX:QBE) as a buy.
Disclosure: Interests associated with Fat Prophets hold shares in QBE Insurance (ASX:QBE).
