Should You Buy QBE Shares (ASX: QBE)?

This article was originally published at MF & Co. Asset Management.

QBE Insurance Group (ASX QBE) is Australia’s largest global insurer, offering general insurance products to personal, business and institutional clients. However as global environmental issues and unpredictable catastrophes occur, QBE shares may face challenges and an uncertain future.  Should you buy QBE Shares?

About QBE Shares (ASX QBE)

In 1886, QBE Insurance Group Limited (ASX QBE) was initially established as North Queensland Insurance Company Ltd (QI) before merging with Bankers’ and Traders’ Insurance Company (Q&T) in 1973. By 1890, it has established over 36 agencies around the world, including London, Singapore, Hong Kong, New Zealand and Australia.

In 2018, the market capitalisation of QBE Insurance stock reached AUD$13.45 billion. QBE Insurance Group Limited accounts for 7.9% of Australia’s general insurance industry valued at AUD$68.3 billion, which is relatively lower than its competitors; Insurance Australia Group Limited (IAG), Suncorp Group Limited (SUN)and Allianz Australia Limited, at 17.3%, 15.1% and 7.6% respectively.

Insurance Industry Developing Through Acquisition Strategy

Experiencing the benefits of a continuous merge and acquisition strategy since 1973, QBE has acquired considerable business lines worldwide, giving the business an edge over competitors through offering diverse insurance services to a global client base.

The business’ wide geographic scope and establishment of divisions in North America, Latin America, Europe, Asia Pacific and Australia & New Zealand has improved QBE’s distribution network, providing the business with plenty of opportunities to tap into new potential markets.

According to IBISWorld, the trend of acquisition activities is expected to continue over the next five years. Moreover, a wide range of product lines and expansion in new countries will contribute to reducing the risk and stabilising performance through diverse risk management practices.

The company has focused on general insurance and reinsurance since 1977. Its long operating history and a broad range of insurance products help QBE gain customer loyalty and trust.

Between 2012 and 2016, QBE won a variety of awards from CANSTAR, Council of Queensland Insurance Brokers, Australian HR Awards and the National Insurance Broker Association.

However, with a rise in natural catastrophes and in the attritional claim ratio, QBE experienced an increase in combined operations ratio from 93.7% to 104.1% in 2017, reflecting a decline in profit. These increases in operation ratios derived from adverse weather related claims in North America and failure in risk selection and underwriting rose from 98.5% to 102.2% and 19.9% to 115.5% respectively.

Increasing Weather-Related Catastrophes Challenge QBE’s Bottom Line

2017 was the second costliest year in history for the global insurance industry.

The main reason for the cost blowouts was the increased severity and frequency of weather-related catastrophe events over the past 20 years, including hurricanes Harvey, Irma and Maria; Cyclone Debbie; the Californian wildfires; a large number of smaller weather-related claims in North America; and a deterioration in QBE Hong Kong workers’ compensation portfolio.

Earnings before tax decreased by $600 million due to these natural disasters. Hurricane Harvey, Irma and Maria and wildfires in California brought together a record of payouts in the insurance industry of a mind-boggling $135 billion to global natural disasters.

In 2017, QBE Insurance underwriting results were disappointing. Climate change continues to threaten the insurance industry as unpredictable weather events and catastrophes increases, leading to significant economic risks and consequences.

Additionally, consequent to increased energy consumption, pollution and global greenhouse emissions, insurers should consider the significant environmental damage and degradation as a future risk on the insurance industry. The US Energy Information Administration predicts a 49% increase in energy consumption from 2007 to 2035. As pollution continues to pose a significant threat to health and wellbeing, QBE should closely monitor atmospheric pollution to accurately access global risk.

After years of losses, premium rates have adjusted for catastrophe losses in 2017 as signs of recovery emerge in the northern hemisphere.

QBE has established a cross-functional Climate Change Working Group to coordinate its approach to managing climate-related events and has also invited the Financial Stability Board’s Taskforce on Climate-Related Financial Disclosures (TCFD) to make recommendations.

At the same time, there are tangible signs of rising global interest rates, and if sustained, rising rates will be a positive change for future investment returns.

QBE Insurance Shares Slowing Growth and Negative Income Compared to the Industry Average

QBE Shares (ASX QBE) revenue growth

Despite ASX QBE shares revenue growth in the past year, its five year average of -3.5% is much lower than the industry’s annual average of 1.5%.

According to IBISWorld forecast, the general insurance industry is expected to grow 4% annually over the next 5 years. However, with pressure from emerging businesses, as well as QBE Insurance Group reaching maturity, it seems that the company has little momentum to grow and catch up to industry growth.

The profit margin of QBE in 2017 was -6.7%, which is below the average profit margin of peers (5.7%), primarily due to the net cost of large individual risk and catastrophes.

Since the net income is negative, a similar position can be seen in QBE’s return on equity of -14.03%, reflecting a relatively low rate compared to industry average of 9.87%.

ASX QBE Shares Faces a Challenging and Uncertain Future

Due to the increasing frequency of catastrophic events, it is difficult to anticipate the economic effect on QBE shares performance.

Furthermore, revenue growth of QBE insurance shares is not as attractive as that of competitors. Investors should be aware of the potential risks and take precaution when investing in QBE shares in the future.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.

Categories: Australian Stocks, Featured

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