We reiterate our Neutral recommendation on PartnerRe Ltd. based on its low-risk balance sheet and above-average liquidity, which are partially offset by rating downgrades, a weak P&C market cycle and low underwriting profitability.
PartnerRe reported an operating loss per share of $2.06 in the fourth quarter of 2011, slightly lower than the Zacks Consensus Estimate of a loss of $2.10. The reported loss per share compared unfavorably with the earnings of $1.33 recorded in the year-ago quarter. Consequently, operating loss substantially plunged to $137.7 million from an income of $98.8 million in the prior-year quarter.
Results deteriorated year over year on the back of declining premiums earned due to cancellations and non-renewals, poor underwriting results, higher catastrophe losses and lower investment income driven by low reinvestment and risk-free rates that led to reduced top line and weak book value growth.
PartnerRe continues to incur high expenses on account of loss expenses and benefit payments on policies. Moreover, prior estimation and provision for losses remain volatile due to the effects of the natural catastrophes that have adversely affected the underwriting results and recorded steep losses in the investment portfolios.
The company recorded about $1.79 billion in pre-tax catastrophe losses in 2011, way higher than $437 million in 2010, nil loss in 2009 and $305 million in 2008, while also leading to a loss of earnings and capital. Such uncertainty and volatility in the magnitude of catastrophic losses not only reduces financial flexibility and reserves of the company but also weakens the underwriting capacity, thereby draining out all the earnings resources.
Over the past years, PartnerRe’s prime reinsurance business has been harshly affected by the ongoing market volatility. Higher competition, low demand, weak pricing as well as lack of any near-term catalyst are further expected to restrict profitability in reinsurance for the upcoming quarters.
Meanwhile, premiums remained quite restrained, primarily in the catastrophe and P&C segments, throughout 2011 due to the portfolio repositioning, following the integration of Paris Re along with price reduction. We do not expect any significant upside on these fronts in 2012 as well.
Additionally, the changing risk profile of the larger and more complex organization that PartnerRe has built itself into, following the Paris Re acquisition, is outpacing the company’s enterprise risk management capabilities. Going forward, the company’s lack of casualty underwriting experience, risk retention by clients and low-risk appetite for reinsurers could result in negative surprises in the future.
The above factors have also reduced the return on equity (ROE), a prime growth metric, to a negative of 10.1% in 2011 against a positive return of 7.1% in 2010 and 22.3% in 2009. Even the combined ratio has been deteriorated to 121.7% in 2011 from 95.0% in 2010 and 81.8% in 2009.
Such concerns over PartnerRe’s operating leverage, catastrophes losses and stability of returns post the Paris Re acquisition has also raised caution among the ratings agencies. While Moody’s and S&P downgraded its ratings, A.M. Best cast a negative outlook on the company recently.
However, hope lies over the fundamental stability of PartnerRe, which is justified by S&P expectation that PartnerRe’s combined ratio should improve to 92–96% in 2012 along with a firm capital competence. Despite the soft market conditions, the company’s above average-risk appetite and apparent underwriting discipline have helped its total adjusted capital to exceed the applicable risk-based capital levels.
Going forward, a fair liquidity with decent operating cash flow and secure credit facilities should provide some cushion to the risk exposure and equity capital in 2012. These factors are expected to help the company achieve a modest ROE at the target rate of 13% in the long term.
Moreover, PartnerRe continues to deploy capital efficiently, while also returning additional value to its shareholders through incremental stock buybacks and dividend hikes. This also helps the company in retaining shareholders confidence in the stock. Any severe repercussion has further been pulled out of the equation given the company’s renewals data of January 2012, which reveal an improved risk profile with respect to its capital base.
Hence, we believe that once the market stabilizes at its historical highs, PartnerRe’s diversified business model and improved pricing can help it generate higher underwriting profitability, investment returns and reserves. This will also enhance its competitive leverage against arch-rivals such as XL Group Plc (XL - Analyst Report) and W.R. Berkley Corp. (WRB - Analyst Report). PartnerRe is scheduled to release its earnings after the closing bell on April 30, 2012.
Based on the pros and cons, the Zacks Consensus Estimate for the first quarter of 2012 is currently pegged at $2.02 per share, substantially up from the loss of $10.82 per share in the year-ago quarter. Of the 15 firms covering the stock, 6 have revised their estimates upwards, while a couple of downward revisions were witnessed in the last 30 days.
Besides, PartnerRe holds a Zacks Rank #3, implying a short-term Hold rating and a long-term Neutral recommendation.