Considering the current market recovery and valued growth indicators, we are upgrading our recommendation for shares of PartnerRe Ltd. (PRE) to Neutral from Underperform.
Although the current economic turmoil has dampened growth and the operating leverage of organizations across the reinsurance industry, we believe that once the economy rebounds, it will also elevate the earnings power of the company.
Despite ongoing challenges at the global economic front, PartnerRe continues to experience a healthy growth trend in premiums earned, benefiting from the consolidation in the global life reinsurance market. Although the strengthening of U.S. dollar could moderate growth in the upcoming quarters, we believe the company is well positioned to attain superior growth from diversified opportunities once the markets revive and macro indices become more favorable.
PartnerRe has been experiencing a sharp growth in net investment income over the last few quarters. This also implies to the strong cash position since the growth of net investment income is drawn on the basis of strong positive cash flow from operations and a straight-forward portfolio of fixed income and equity securities that steer clear of alliances and hedge fund investments. This smooth cash generation is expected to be a dependable source for investment income in the upcoming quarters.
Moreover, the acquisition of Paris Re is well positioned for PartnerRe’s long-term goals, as it appears to blend well with the company’s core growth strategies. Furthermore, the acquisition has augmented total capital to approximately $8 billion as of March 31, 2010. Although near-term risks related to amalgamation, finances and proper execution prevails, the Paris Re acquisition is projected to generate earnings and add to shareholder value in the long run.
In addition, the company enjoys above-average liquidity and a low-risk balance sheet. Despite the soft market conditions and catastrophe losses, PartnerRe’s above-average risk appetite and apparent underwriting discipline have helped it maintain a five-year average underwriting combined ratio of 91.4%, which is satisfactory compared with its peer group. This also paves the way for a modest return on equity (ROE) at the target rate of 13% in the long term.
PartnerRe continues to enjoy a stable outlook for its securities and debts from rating agencies such as S&P, Moody’s Investor Service, Fitch and A.M. Best. In fact, last week, A.M. Best reiterated its ratings and stable outlook on the company. Not only does this enhance the goodwill and market value of the company, but also reflects PartnerRe’s conservative investment strategy, reserve strength, low level of recoverable reinsurance and low reliance on retrocession reinsurance.
However, PartnerRe still incurs a huge expense on account of loss expenses and benefit payments on life policies. Moreover, natural catastrophes have adversely affected the underwriting results and recorded steep losses in the investment portfolios. Recently, PartnerRe experienced a deepwater rig explosion loss of around $60-$70 million. This not only reduces financial flexibility and reserves of the company but also weakens the underwriting capacity.
PartnerRe stays modestly invested in Commercial Mortgage-Backed Securities (CMBS). These instruments have been underperforming due to the continued weakness in the commercial and real estate markets. In addition, the recent massive government intervention has led to a lower level for risk-free rates that make up a meaningful amount of the industry’s investments. These risks are expected to put pressure on investment income growth in the upcoming quarters.
PartnerRe appears to provide an earnings cushion to the substantially exposed and softening P&C cycle. Meanwhile, 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.
Given the ongoing market volatility as an after effect of the global economic turmoil, PartnerRe’s prime reinsurance business has been harshly affected. Higher competition, low demand, weak pricing as well as lack of any near-term catalyst are further expected to restrict additional profitability in reinsurance in the upcoming quarters.
Overall, PartnerRe is well poised for growth once the economic conditions become more favorable. However, PartnerRe’s exposure to catastrophic losses, weak prospects in the underwriting sphere, higher expenses and risk related to the Paris Re integration amid the ongoing market volatility restricts growth visibility and the stock’s upside.
Therefore, our near-term outlook remains shady, though fundamentally PartnerRe has the potential to outperform the industry in the long run. While a strong balance sheet and liquidity generate operating leverage, the recent rating affirmation from A.M. Best also suggests long-term stability.
Read the full analyst report on “PRE”
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