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Credit Suisse says the blue-chip insurance sector is poised for a profit upgrade

You’d be forgiven if you struggled to think of a sector on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) that is deserving of an upgrade outside of resources.

It’s hard to think about profits beating expectations during the dreaded company confession season and the volatile macro environment that is rocked by cracks in the Chinese economy and the threat of an outbreak of a global trade war.

But the June quarter has been particularly good to insurers and that means wide spread profit upgrades for the sector, according to Credit Suisse.

“The recent quarter largely saw a reversal of what happened in 1Q18 in regards to investment market movements for the insurers’ portfolios,” said the broker.

“The ASX accumulation index was up 8.0% in the June quarter (+4.0% in the half) while global equities were up 1.1% in USD terms (down 0.7% in the half), but up 4.8% in AUD terms (+4.7% for the half). Bond yields displayed minimal change in most regions with the three-to-five-year Australian corporate spreads expanding further in the quarter.”

In spite of these supportive factors, the share price performance of our insurers has been mixed with AMP Limited (ASX: AMP) suffering the worst, although that is largely due to the shock revelations of bad behaviour at the Banking Royal Commission, while Insurance Australia Group Ltd (ASX: IAG) and Suncorp Group Ltd (ASX: SUN) have outperformed in the latest quarter.

Credit Suisse has upped its FY18 earnings per share (EPS) forecast for IAG and Suncorp by around 9% each due to the benign weather and a positive performance in the share market, although AMP only got a 0.6% uplift.

Health insurers Medibank Private Ltd (ASX: MPL) and NIB Holdings Limited (ASX: NHF) also enjoyed upgrades of a little over 3% each on positive equity markets in the quarter, although internationally exposed QBE Insurance Group Ltd (ASX: QBE) suffered a 3.1% reduction in its earnings forecast due to the decrease in European bond yields.

But despite the upgrades, value is not easy to come by in the sector and there are a number of headwinds brewing on the horizon.

“While valuations appear stretched for the domestic insurers, IAG and SUN, the operational environment remains favourable, with ongoing premium rate increases assisted in the half by benign weather and positive equity markets,” said Credit Suisse.

“There remains outer year upside risk to both IAG and SUN if premium momentum continues and cost-out targets are achieved.”

What this means is that there isn’t a good enough reason to buy these stocks at the moment and Credit Suisse has a “neutral” rating on both.

The near-term operating conditions for health insurers are also generally positive but the looming federal election could impose regulatory risk on the sector, while the wobbling European market creates uncertainty for QBE.

As surprising as it might sound to some, AMP is the only one in this group that Credit Suisse thinks is a buy on valuation grounds. The stock is trading at a circa 35% price-earnings (P/E) discount to the market and its share price is around 33% below the broker’s price target of $4.80 a share.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of Insurance Australia Group Limited. The Motley Fool Australia has recommended NIB Holdings Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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