Why the market loves insurance companies right now

Any discussion of Australia’s finance sector often begins with the big banks, in which we all have a vested interest. That’s because of their gargantuan presence in the local borse and our compulsory superannuation system, with most funds substantial shareholders in one or all of them.

But there’s a strong view that the local banks’ best times are behind them. 

Mark Landau, one of the investment brains behind the top performing L1 Capital Long Short Fund, said as much recently. 

A quick scan of the Broker Consensus widget on Market Index shows the following:

• Commonwealth Bank (ASX: CBA) – STRONG SELL: 0 Buys, 5 Holds, 15 Sells
• National Australia Bank (ASX: NAB) – HOLD: 9 Buys, 5 Holds, 4 Sells
• ANZ Group Holdings (ASX: ANZ) – BUY: 12 Buys, 4 Holds, 2 Sells
• Westpac (ASX: WBC) – SELL: 2 Buys, 8 Holds, 8 Sells
• Macquarie Group (ASX: MQG) – BUY: 11 Buys, 5 Holds, 0 Sells.

A key theme for the banks this AGM season has been their continuing cost problems, as reflected in their net interest margins (NIMs). Three of the biggest four – Westpac, ANZ Group and National Australian Bank – each called out thinning NIMs when they delivered FY23 results earlier this month. Commonwealth Bank’s market update on Tuesday also indicated lower NIMs caused by, “continued competitive pressure in deposits, and customers switching to higher-yielding deposits.”

That’s one of the reasons Australian insurers are currently a preferred exposure to the Financials sector for many professional investors, including:

• L1’s Landau, who discussed how he ditched Australian banks while retaining exposure to the financial space via insurer QBE during his Livewire Live presentation in September.
• Airlie Asset Management’s Emma Fisher, portfolio manager of the Airlie Australian Share Fund, who recently discussed QBE with equity analyst Joe Wright.
• Lazard Asset Management’s Aaron Binsted, who said back in August that the potential upside in Aussie banks was too low to compensate for the risks.

What the brokers say

In terms of market cap, Australia’s largest insurers slot in directly beneath the big 5 (the banks including Macquarie Group), ranking #6, #7 and #8 within the ASX Financials sector.

Goldman Sachs recently reiterated its BUY ratings across each of the following names on the back of its analysis of global reinsurers Munich RE, SCOR, Swiss RE and Hannover RE.

"Strong Reinsurer profit trends / ROEs bode favourably for the direct insurers, noting most of the pain on price appears to have been taken, with some reinsurers flagging new business growth,” said analysts Julian Braganza, FIAA, and Brian Kim in a recent sector report.

They regard the latest result from the global reinsurers as “a positive read for QBE / IAG at their upcoming renewals as well as SUN into next year. We also note that sector capital appears to have improved.”

Here’s what Goldman Sachs and other brokers have to say about Australia’s biggest insurance companies. Note: Goldman Sachs kept its BUY rating in place for each of the three insurers but has lifted its price targets.

QBE Insurance Group (ASX: QBE)

• Market cap: $22.36 billion
• 12-month return: 21.91%

Airlie Asset Management is most excited about QBE’s “middle market” insurance business, which services small-to-medium enterprise customers. It’s in this part of the market that Airlie analyst Joe Wright sees the most growth potential.

On the back of a recent research trip to the US, “the feedback is that the sector is on fire, with a really strong rate growth, good operating leverage, and is now finally getting returns on its investment portfolio after a pretty average five years,” Wright said.

“All of which is driving material earnings growth across the whole sector. A rising tide lifts all boats in many respects, and QBE is benefiting from that.”

Based on QBE’s latest closing price of $14.97, the company currently trades 18% below Goldman Sachs’ $18.09 price target.

On 4 October, Morgan Stanley issued a report on the local insurers, reiterating its OVERWEIGHT rating on QBE, analysts lifting their price target to $18.30 from $18.20.

Jefferies added QBE to its coverage list on 7 May 2023, with a BUY rating and a price target of $18.08.

QBE shares closed at $15.05 on Wednesday 15 November 2023.

Suncorp Group (ASX: SUN)

• Market cap: $17.04 billion
• 12-month return: 12.92%

The failed divestment of its banking arm to ANZ Group, after the deal was scuppered by the ACCC in a decision that fronts the appeals court next month, is the latest news surrounding Suncorp. But its insurance business is a key underpinning of the group’s $1.25 billion full-year profit management reported in August.

Suncorp was named as a stock to watch by Investors Mutual portfolio manager Michael O'Neill in a September edition of Buy Hold Sell. He believes Suncorp has positioned itself well for top-line growth and margin expansion in the next 18 months to 24 months.

“I think of insurers as a bit of a later cycle play on rising rates than banking because their investment earnings have been earning around 1.5% and they grew to 5% with this current result,” he said.

Goldman Sachs lifted its price target for SUN to $15.13 in August, up from $14.53.

Morgan Stanley also rates SUN as a BUY. On 24 July, the investment bank lifted its price target to $15.70 from $14.50.

Suncorp shares were trading at $13.41 when the market closed on Wednesday 15 November.

Insurance Australia Group (ASX: IAG)

• Market cap: $14.1 billion
• 12-month return: 19.3%

Last month's AGM delivered mixed news for shareholders of Australia’s largest general insurer. On one hand, IAG is seeing its profit margins squeezed by rising costs – in part because of rising car repair costs alongside older insurance claims. But the company has so far been successful in passing higher costs through to policyholders, management indicating its second half will likely benefit from this “earn-through of pricing”.

IAG was called out recently by Yarra Capital’s Edward Waller as one of the highest-conviction holdings in its Yarra Ex-20 Australia Equities Fund. 

He noted the firm's success in ramping up premiums in response to rising costs but also pointed to the weather outlook as a positive. The drier conditions of the El Niño we’re currently moving into lowers the probability of extreme weather events.

“It’s currently trading on less than 15 times forward earnings, which we regard as a reasonably undemanding multiple. We view IAG very much as a core holding in the portfolio,” Waller said.

IAG is rated NEUTRAL by Goldman Sachs, which sets a price target of $6, up from $5.87 in August.

Morgan Stanley rates IAG as EQUAL-WEIGHT, with a $5.45 price target as of 21 August 2023, up from $5.25.

Morgans upgraded IAG to ADD from Hold on 12 October, but analyst Richard Coles reduced his price target to $6.24 from $6.26.

Insurance Australia Group shares traded at $5.81 when the market closed on Wednesday 15 November.