Top brokers think this ASX sector is at risk of a downgrade

S&P/ASX 200 (Index:^AXJO) (ASX:XJO) shares in this sector could disappoint as we head into the August reporting season. Here are the ones to buy and avoid.

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It’s getting trickier to invest in the insurance sector as there are parts of this industry that could be facing disappointments and downgrades as we head into next month’s reporting season.

The interest rate cuts by the Reserve Bank of Australia (RBA) is making life harder for ASX-listed insurers as well. A low rate environment makes it harder for these companies to generate a return on the premiums they collect.

This could leave them little choice but to increase premiums but their ability to squeeze more from customers is limited for two reasons, according to Macquarie Group Ltd (ASX: MQG).

Insurers facing earnings squeeze

Firstly, any price increase could cause our S&P/ASX 200 (Index:^AXJO) (ASX:XJO) insurers to lose market share to smaller rivals. Secondly, there’re signs that conditions are turning for general insurers.

“The Australian insurance premium rate cycle has passed the peak – i.e. the pace of premium rate increases is slowing,” said the broker.

“[Further] Australia is the only major market to have increased its Commercial lines prices since 2013, which lead us to believe the pricing cycle could be over sooner than expected.”

Macquarie’s view coincides with Morgan Stanley downgrading its recommendation on Suncorp Group Ltd (ASX: SUN) and Insurance Australia Group Ltd (ASX: IAG).

Best and worst ASX insurers

Suncorp is at risk of issuing a disappointing profit guidance, in Morgan Stanley’s view and the broker has cut its rating on the stock to “underweight” from “equal-weight”.

“SUN’s 2H will likely show it continuing to struggle on personal lines volumes,” said the broker, who has an $11.90 per share price target on the stock.

“Guidance will likely disappoint as SUN balances growth campaigns (i.e., lower pricing) to restore franchise momentum alongside the need to price for a higher FY20e CAT budget (+A$100m) and the impact of lower yields.”

Insurance Australia cops a downgrade to “equal-weight” after the IAG share price jumped 21% since the start of the 2019 calendar year and has hit the broker’s price target of $8.50 a share.

“The investment case remains robust. However, there is risk a rising CAT budget, lower yields and elevated compliance costs contribute to softer than expected FY20e guidance with reserve releases likely falling back to 1.0%,” added Morgan Stanley.

But this isn’t to say there’re aren’t any buying opportunities in the sector. Morgan Stanley believes QBE Insurance Group Ltd (ASX: QBE) is the standout in the sector, while Macquarie favours insurance brokers such as Steadfast Group Ltd (ASX: SDF) and AUB Group Ltd (ASX: AUB).

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Motley Fool contributor Brendon Lau owns shares of Macquarie Group Limited. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of and has recommended Macquarie Group Limited. The Motley Fool Australia owns shares of Insurance Australia Group Limited. The Motley Fool Australia has recommended Steadfast Group Ltd. 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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