We have reiterated our Neutral recommendation on PartnerRe Ltd. (PRE) based on the recent catastrophe (CAT) losses that have severely dampened the bottom line, partially offset by a risk-free balance sheet and a fair amount of liquidity.
PartnerRe’s second quarter operating earnings per share of 98 cents came in significantly higher than the Zacks Consensus Estimate of 68 cents, but lagged behind $1.80 recorded in the year-ago quarter.
Results deteriorated year over year on the back of higher CAT losses, declining premiums written, poor underwriting results and lower investment income driven by low reinvestment rates, which thereby led to tepid top line and book value growth.
To achieve effective and efficient capital allocation, PartnerRe focuses on operating ROE. Despite reducing the share count through a series of share buybacks and artificially inflating earnings per share, the company’s annualized operating ROE declined to a negative of 21.0% in the first half of 2011 against positive returns of 7.1% in 2010 and 22.3% in 2009.
Furthermore, the company’s increased expenses and weak operating leverage have not only adversely affected the returns, but its combined ratio also deteriorated to 147.1% in the first half of 2011 from 95.0% in 2010 and 81.8% in 2009. As a result, operating leverage has also been dampened by substantial losses, poor top-line growth and higher catastrophe losses in the last few quarters. These factors pose adequate caution for future earnings growth capacity.
Given the ongoing market volatility caused by the after-effects of the global economic turmoil, PartnerRe’s prime reinsurance business has been severely affected. In addition, higher competition, low demand, weak pricing, a sluggish property & casualty cycle and a lack of any near-term catalyst are further expected to restrict profitability in reinsurance in the upcoming quarters.
On the flip side, PartnerRe enjoys a stable ratings outlook from most of the rating agencies that are cautious of the company’s near to intermediate term, given the CAT losses, integration risks associated with the Paris Re acquisition and weak macro dynamics. However, the rating agencies have confidence on PartnerRe’s overall operational synergies for a strong competitive position, superior balance sheet and solid long-term operating profitability that strengthens its long-term growth profile.
With the reduction in volatility and improvement in pricing, the company is expected to generate at least 10% compound annual growth in book value per share, reflecting a stable outlook in the long run. Moreover, despite the soft market conditions, the company’s above average risk appetite and apparent underwriting discipline have helped its total adjusted capital exceed the applicable risk-based capital levels. These factors are expected to help the company achieve a modest ROE at the target rate of 13% in the long term.
Meanwhile, PartnerRe continues to return additional value to its shareholders through stock buybacks and dividend payments, thereby retaining the investors’ confidence in the stock.
Overall, PartnerRe enjoys a diversified business model, both geographically and across its reinsurance portfolio. Furthermore, as a part of its core strategy, the company is focusing on underwriting, actuarial and financial areas that are critical to maintaining an independent view of risk. These factors together have contributed to more stable earnings, increase in return per unit of risk and better underwriting profitability as compared to many of its peers.
Going forward, once the market stabilizes at its historical highs, the company’s diversified business model and improved pricing can help it generate higher underwriting profitability, investment returns and reserves.
Given all the pros and cons, the Zacks Consensus Estimate for the third quarter of 2011 currently stands at $2.21 per share, down 40% over the prior-year quarter. For 2011, estimated loss per share stands at $5.57, declining from earnings of $6.63 per share. PartnerRe primarily competes with Everest Re Ltd. (RE) and W.R. Berkley Corp. (WRB) in its operational universe, carrying Zacks recommendations of Neutral and Outperform, respectively.
Additionally, the quantitative Zacks Rank for PartnerRe is currently #3, indicating no clear directional pressure on the shares over the near term.
PARTNERRE LTD (PRE): Free Stock Analysis Report
EVEREST RE LTD (RE): Free Stock Analysis Report
BERKLEY (WR) CP (WRB): Free Stock Analysis Report
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