QBE: Interim result 2013

QBE’s share price initially fell 9% after the company announced a poor interim result (QBE has a calendar year end). Revenue, measured by gross written premium (GWP), increased 2% to US$9.4bn compared to the same period last year, and net earned premium was flat at $7.3bn, as the company sold or exited poor performing businesses and the US division continued to struggle.

At 92.8% the combined operating ratio was flat, but with investment income falling 42% to US$394m and historical or ‘prior year’ claims increasing significantly net profit fell 37% to US$477m. Earnings per share also fell 43% to US35.8 cents. The poor result was boosted by a favourable $177m change in interest rates, which should be excluded from any estimate of QBE’s long-term earnings power.

Only 37% of cash earnings will be paid as dividends, compared to the company’s target of 50%, as cash earnings fell 30% to US$590m due to low investment returns. The second half of the year can also produce large natural catastrophe claims. The interim fully franked dividend of 20 cents was sawn in half (estimated ex date 18 Sep), and the dividend reinvestment plan remains in place with a 1% discount.

The Australia and New Zealand business performed well despite interest rates falling. Premiums increased 6.5%, well above the global average of 5%, and GWP increased 4% to $2.5bn. The insurance margin fell from 18.5% to 17.3%, and the insurance profit fell 4% to $US359m, as the previous period included a large benefit from tightening credit spreads.

The combined operating ratio fell back to 89.9% following a massive increase in natural catastrophe claims over the past couple of years. Management expects premiums to increase another 4-5% next year, which also augurs well for rivals such as Suncorp and Insurance Australia Group.

Once again the villain was the US division, where GWP fell 16% to $2.7bn despite a 6.9% increase in property and casualty premiums. Management now expects annual GWP to be $600m lower than previously forecast. The insurance profit margin fell from 8.0% to a lowly 6.9%, and the insurance profit fell 31% to just US$89m.

QBE is exiting poor performing businesses but the US lender-placed mortgage insurance business remains problematic. The combined operating ratio remains stubbornly high at 94.5%, but should eventually fall back below 90% with better management.  

Even if management achieves its company-wide full year target for a combined operating ratio of 92%, insurance margin of 11% and paltry investment return of 2.2%, as it expects, the company either needs the US division or investment returns to improve dramatically to significantly increase profits and dividends. Chief executive John Neal has installed new managers in the US but the task of changing QBE’s culture, rationalising its IT systems and processes and increasing revenue shouldn’t be underestimated.

We’ll revisit the recommendation guide if the stock price reaches $18, but with the share price increasing 11% since 10 May 13 (Hold – $14.52) for now we’re sticking with HOLD.

Note: The model Growth and Income portfolios own shares in QBE Insurance.

Note: Consider your portfolio limit particularly carefully if you also have a large exposure to banks or residential property, as QBE also has a large exposure through its LMI mortgage insurance division.