RenaissanceRe Drops to Underperform

We have downgraded our recommendation on RenaissanceRe Holdings Ltd. (RNR - Analyst Report) to Underperform from Neutral based on the company’s poor operating results in the third quarter, coupled with the declining interest rate scenario, which have also led to a reduced earnings outlook for the fourth quarter of 2011.

RenaissanceRe reported third quarter operating income per share of 62 cents, lagging the Zacks Consensus Estimate of 84 cents and prior-year income of $1.59. Operating income showed a sharp decline to $32.7 million from $90.9 million reported in the year-ago quarter.

Natural catastrophes have been impacting the profits of RenaissanceRe since 2008. During the first half of 2011, the company was severely hit by floods in Australia, earthquake in New Zealand, earthquake and tsunami in Japan and tornadoes in the U.S. These catastrophes made the period the costliest semi-annual period for RenaissanceRe, even though there was marginal improvement in the situation in third-quarter 2011.

Moreover, while RenaissanceRe’s cash flows from operating activities are significantly in excess of its operating commitments, a hefty portion of it goes in covering losses from unpredictable natural calamities. Cash flows are impacted negatively as the actual losses from such events varies from their preliminary estimates.

Additionally, the company’s poor performance in private equity, hedge fund, high yield funds and bank loan contributed to dismal investment results in the third quarter of 2011. Although the company maintains a strong dollar-weighted average rating on its invested asset portfolio of fixed maturities and short-term investments, yet the steep decline in interest rates and widening credit spreads have led to declining total returns on the fixed maturity investment portfolio in 2010 and so far in 2011.

However, RenaissanceRe has a limited sub-prime exposure as its mortgage-backed portfolio consists of highly rated fixed income securities. Besides, the company has no investments in collateralized debt obligations and collateralized loan obligations. Moreover, the company has strong debt and credit ratings.

RenaissanceRe has been deploying its excess capital to enhance shareholders’ wealth during the past several quarters. Alongside, the company hiked its quarterly dividend and also expanded its stock repurchase program in the beginning of 2011. Furthermore, RenaissanceRe repurchased 2.7 million shares during the first quarter of 2011 for $174.8 million, although there were no repurchases in the second and third quarters of the year.

Overall, we expect poor upside potential for RenaissanceRe shares over the near term as it faces increasing challenges in its investment portfolio. The Zacks Consensus Estimate for fourth-quarter 2011 is currently $2.02 per share, down 42% year over year. For full year 2011, the Zacks Consensus Estimate stands negative at $2.16 per share, down by a substantial 123% from 2010.

RenaissanceRe carries a Zacks #3 Rank, which translates into a short-term Hold rating, indicating no clear directional pressure on the shares over the near term. It competes with ACE Limited (ACE - Analyst Report) and XL Group Plc. (XL - Analyst Report).

Read the full analyst report on RNR

Read the full analyst report on XL

Read the full analyst report on ACE