We are retaining our Neutral recommendation on XL Group (XL), given its exposure to catastrophe losses, declining net investment income and increasing operating expenses.
Though the entire industry benefited from lower cat loss in the first quarter, exposure to cat activities will always remain a concern, as natural disasters can affect the company’s results adversely. Because of lower cat activities, XL Group booked underwriting profit, rebounding from the year-ago loss. Also, there was an improvement in its combined ratio.
Net investment income at XL Group has been on a declining trend for the past few years, and the first quarter was no exception. It experienced lower investment rates and cash outflows from the investment portfolio, thereby affecting net investment income. With performance closely linked to credit markets, which remain volatile, the exposure to these assets can further cause uncertainty in investment earnings.
Operating expenses are on an increasing trend augmenting 8% in the first quarter, primarily attributable to the build-out of previously announced initiatives.
However, counting on the positives, XL Group remains focused on those lines of business within its insurance and reinsurance operations that provide the best return on capital over the pricing cycle. New business initiatives in North American Property & Casualty lines, higher retention levels, and improved pricing aided the uptick at Insurance.
Higher premiums at the Reinsurance segment largely came from the International segment. With a strong international exposure and a diversified array of product offerings, we believe the company is well positioned to write higher premiums, thus fueling top-line growth, going forward.
XL Group continues to enhance shareholders’ value through dividend payment as well as share repurchase. The company is left with $650 million under its authorization after pursuing share buyback worth $100 million in the first quarter of 2012.
Rating affirmations or upgrades from credit rating agencies play an important part in retaining investor confidence in the stock as well as maintaining creditworthiness in the market. XL Group scores strongly with the rating agencies. Recently, Fitch Ratings affirmed the Issuer Default Rating (IDR) at ‘BBB+’ of XLIT Ltd., a subsidiary of XL Group.
The rating agency also affirmed the Insurer Financial Strength (IFS) rating of its core operating companies at ‘A’. We believe, the company’s strong ratings scores will help retain investor confidence and help it to write more businesses going forward, thereby augmenting the results.
The quantitative Zacks #4 Rank (short-term Sell rating) for XL Group indicates downward pressure on the shares over the near term. The company competes with ACE Limited (ACE).
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