QBE Insurance

Fat Prophets

Friday 18th September 2015

Sharechat Hot Stock: QBE Insurance (QBE.ASX)

On the cusp of an upswing in the insurance cycle

What’s new?

QBE Insurance reported an interim net profit of US$455 million for the six months ending 30 June 2015. Adjusting for one-off costs this was US$488 million, which compares favourably to the US$392 million reported at last year’s interims. The good 1H15 result, in combination with the recent completion of some capital initiatives, enabled the Board to declare a fully franked interim dividend of 20 Australian cents.

The 33 percent lift on last year’s dividend was predicated on the Board’s decision to increase the maximum payout ratio from 50 percent to 65 percent. In Fat Prophet’s view, the higher dividend is indicative of QBE Insurance’s strong capital position (i.e. the company’s capital base is in excess of its minimum requirements) and the Board’s confidence in future earnings.

The key drivers of QBE Insurance’s 1H15 results were the combined operating ratio and the insurance profit margin, both of which were at the upper end of the company’s target range. While the 70 basis points increase in the insurance profit margin to 10 percent was a great outcome given that investment income was lower during the period, the improvement in the combined operating ratio was equally impressive, having been driven by a 4.5 percent reduction in the claims ratio.

In terms of QBE Insurance’s performance by region, the key laggard remains North America, where increased catastrophe claims coupled with a higher underlying combined commission and expense ratio resulted in some slippage in the region’s combined operating ratio compared to 1H14. Elsewhere, Australia & New Zealand also lost some ground on the back of competitive pressures and multiple weather-related catastrophes, while Europe and Equator Re reported solid gains.

Outlook

After adjusting for foreign exchange sensitivities and asset disposals, management’s guidance for CY15 remains unchanged. That is, management expects QBE Insurance will generate (i) gross written premiums of US$15.2-15.6 billion (US$8.6 billion in 1H15), (ii) net earned premiums of US$12.3-12.7 billion (US$6.1 billion in 1H15), (iii) a combined operating ratio of 94-95 percent (93.4 percent in 1H15), and (iv) an insurance profit margin of 8.5-10 percent.

It is no secret that low interest rates have been an earnings headwind for the insurance sector for a while now. While this has put pressure on investment income and premium prices more generally, we believe the tide could be about to turn with longer dated US bond yields now trending higher. In Fat Prophet’s view, this bodes well for QBE Insurance given the low duration of the company’s investment portfolio and the positive correlation between its share price and the US 10 year bond rate.

Price

Looking at QBE’s share price chart, the outlook has weakened a little. However, with prices continuing to tread above the 200-day moving average, further consolidation at current levels will augur well for a near-term recovery, with a renewed challenge of resistance at $16 likely over the medium-term. This appears consistent with QBE Insurance’s current fundamentals of 13.5 times CY15 earnings, 1.1 times CY15 book value and dividend yield of 4.0 percent.

Worth buying?

There are three key reasons to buy shares in QBE Insurance. First, the recent increase to the upper end of the company’s payout ratio, which increases the potential for higher dividends going forward. Second, management’s continued focus on operating efficiencies, which are having a positive effect on profitability. Last, the short duration of QBE Insurance’s fixed interest portfolio, which bodes well for investment income once the Federal Reserve starts to raise rates.

James Lennon is a Senior Analyst at investment research and funds management house Fat Prophets.

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Disclosure: Interests associated with Fat Prophets declare a holding in QBE.

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