Key statistics: ASX: QBE
Closing share price 31.01.17: $12.500
52-week high: $12.970
52-week low: –
Most recent dividend: 21c
Annual dividend yield: 4.13%
Investor appetite for QBE Insurance has spiked in recent months, with the shares rallying around 15% since mid-November. The fact that this has occurred despite a period of subdued news flow from the company itself highlights the top-down thematics that the insurer is leveraged to, which are swinging more in QBE’s favour.
All things being equal, the onset of rising bond yields is positive for the company’s investment income, while general inflationary pressures are also typically a tailwind for insurance premium pricing.
QBE has underperformed the broader stockmarket since the GFC, and it is no coincidence that this has been during a period of ultra-low interest rates and an ongoing bull market in bonds. This dynamic has suppressed returns on the company’s investment portfolio, as it has for many insurers. This has also marked a continuation of the historic high correlation between the share price and the yield on US government bonds. The winds, though, are set to blow more in the company’s direction, in our view.
A key turning point has come with the election of Donald Trump as the US’s 45th president.
He has made his intentions very clear as they relate to “Making America great again” and is set to embark on an ambitious spending program: “We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals” and “We’re going to rebuild our infrastructure, which will become, by the way, second to none. And we will put millions of our people to work as we rebuild it.”
The plan is a bold one, and fiscal spending on this scale will ultimately provide an inflationary boost. This prospect has provided equity markets with a “Trump bump”, while fixed-income yields have risen and bonds have been sold off.
While QBE recently denied press speculation that it has received an informal takeover offer of $15 a share from insurance giant Allianz, we are inclined to think that where there is smoke there is fire. If we are right about a looming inflection point in the insurance cycle, then now is the perfect time to be considering industry consolidation.
We believe that the recent steepening of the yield curve is a sign of things to come, although the great rotation from bonds to equities is unlikely to be a linear or orderly progression. The bond market is unlikely to roll over without a fight, and a “counter reaction” is probably imminent. The global economy still has frailties, so central banks will once again be a key part of the mix, both in terms of actions and what they say.
We saw this again in December in the US when the Federal Reserve raised the benchmark rate by the expected 0.25% but struck a “dovish” tone. The path of rate increases this year will be relatively gradual and measured, with the fact that the greenback is at its highest levels in over a decade not lost on the Fed.
However, not even this is likely to stop the bigger primary trend, which is an encroaching secular bear market in bonds that is likely to endure for quite a few years. We envision the yields on 10- and 30-year treasuries moving towards 4% in 2017. Should this play out, the re-rating in QBE Insurance should have much further to go.
This is because the onset of inflation and higher interest rates will also provide top-line impetus to QBE as the premium pricing environment becomes more favourable and as risk is re-priced. This also sets the scene, in our view, for an inflection point in the insurance cycle. In this scenario QBE is likely to see a material improvement in premiums written (growth) and underwriting excellence (operating margins).
QBE is trading on an earnings multiple for 2015-16 of 15.5 times, falling to 13.3 times for 2016-17 and 11.5 times for 2017-18. The company, meanwhile, offers a prospective yield for 2016-17 of around 4.3%. Supplementing this favourable pricing profile is QBE’s technical set-up, with our analysis suggesting that the shares should trend towards resistance (the 78.6% Fibonacci retracement) at $13.44 over the medium term.
With some positive top-down tailwinds finally on the horizon and QBE’s business transformation program well progressed, we believe the company’s shares are now offering strong value over the medium term.