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Beazley's rating looks too lofty

Beazley is a high-quality underwriter, but premium rates are falling and the shares are the most expensively rated among its peer group
November 13, 2014

Beazley's (BEZ) reputation as a high-quality underwriter is certainly deserved. At the half-year stage, for instance, it reported a combined ratio (of claims to premiums) of 90 per cent - signalling a solidly profitable underwriting performance. But Beazley's shares are also the most expensively rated in its peer group and, with premium rate pressure continuing to mount, it's hard to see that lofty rating being maintained.

IC TIP: Sell at 264p
Tip style
Sell
Risk rating
Medium
Timescale
Long Term
Bull points
  • Fat dividend yield
  • Solid underwriting profits
Bear points
  • Premium rates are sliding
  • Investment returns remain uninspiring
  • Earnings forecast to fall
  • Shares expensively rated for the sector

Admittedly, the claims environment remains remarkably benign. Munich Re estimated that globally insured losses reached around $17bn in the first half, which is modest compared with loss events seen in recent years. In 2011, for instance, earthquakes in Japan and New Zealand pushed the global insured loss up to $105bn, while Hurricane Katrina alone delivered a loss of around $70bn in 2005. Moreover, this year's hurricane season, which officially closes at the end of this month, has again been mild. The last Atlantic storm to generate notably large losses was Hurricane Sandy in 2012.

 

 

But while an absence of costly claims is good for short-term earnings, and helps explain Beazley's robust underwriting performance, it has big implications for longer-term earnings. That's because it leaves underwriters overcapitalised and tempted to compete for business by cutting prices. Another factor is the influx of new capital into the sector from such sources as hedge funds and pension funds also puts premium rates under pressure. With low interest rates, and against the backdrop of years of quantitative easing, investors' search for yield has led to a focus on less traditional assets.

That pricing pressure is now beginning to build. With its third-quarter figures this month, Beazley revealed that premium rates for reinsurance cover have tumbled 10 per cent, while marine business prices have fallen 6 per cent. Modest pressure is apparent elsewhere, too: the property book saw rates fall 1 per cent and the political risk and contingency book suffered a 3 per cent price slide. The group's largest business line - speciality lines - did see rates rise, but by a slender 1 per cent. In fact, Beazley's only strongly performing account was its life, accident and health book, where rates jumped 11 per cent. That, however, generates just 7 per cent of group premiums. Moreover, and given the benign claims backdrop, those pricing pressures look set to intensify. Broker Numis Securities expects Beazley's earnings to fall a fifth between end-2013 and end-2015.

BEAZLEY (BEZ)

ORD PRICE:264pMARKET VALUE:£1.38bn
TOUCH:263-264p12-MONTH HIGH/LOW:274p217p
FWD DIVIDEND YIELD:6.9%FWD PE RATIO:10
NET ASSET VALUE: 152pCOMBINED RATIO:90%

Year to 31 DecGross premiums ($bn)Pre-tax profit ($m)*Earnings per share (p)*Dividend per share (p)
20111.7162.78.07.9
20121.9025125.816.7**
20131.9731332.024.9**
2014*1.9725926.719.5
2015*1.9624125.318.2
% change-1-6-5-7

Normal market size: 7,500

Matched bargain trading

Beta: 0.93

*Numis Securities forecasts, adjusted PTP and EPS figures

**Includes special dividends: 16.1p in 2013 and 8.4p in 2012

£1=$1.59

In today's ultra-low interest rate world, investors can't expect much support from Beazley's investment portfolio, either. The book is largely focused on cash and high-quality bonds and, at the third-quarter stage, its annualised return reached 1.9 per cent. That's nothing unusual for the sector - Hiscox's (HSX) annualised returned was 2 per cent at the half-year stage, for instance - and it isn't quite keeping pace with inflation, either (UK retail price index inflation was 2.3 per cent last month).

Such a weak rating outlook could, however, leave Beazley struggling to profitably deploy capital and that makes capital returns, through special payouts, highly likely. And, based on Numis' estimates, the shares offer an end-2014 prospective yield of over 7 per cent. But plenty of Beazley's peers are in the same boat - most are thought likely to return capital - so that fat payout isn't so special. Indeed, Numis' estimates suggest a prospective yield for rival Brit (BRIT) of over 13 per cent, while shares in Lancashire (LRE) offer a prospective yield of nearly 10 per cent.