QBE Insurance is on our shares to buy list if we were adding positions to our investment portfolio. Unlike health insurers like Medibank (MPL ASX) which just focus on Australia. It is the only property and casualty (P&C) insurer listed on the ASX that has operations around the globe.
The company has been in recovery mode since the GFC where the strategy has shifted from acquisition led growth and growing top line premiums to focus on improving current operations and being more selective in the markets where it wants to operate.
We been reluctant in taking a position due to numerous issues in the underlying business. However given the time frame of the clean up, there seem to be light at the end of the tunnel. If there is a pull back in the broader market indices (e.g ASX 20), we would look to initiate a position ourselves.
Quick thoughts on the company
- From the operation perspective the management have stopped the decline in gross written premiums and realigned the cost structure for the business. With the core business stabilized, the focus will return to sustainable shareholder return on equity and top line growth.
- QBE investment portfolio is conservative with majority of allocation to fixed income. Investment income has been depressed in the last 5 years due to the structural decline in interest rates across the globe. European rates are near zero, US 10 year treasury at time of print is sub 2%. Our view is that the rate market has stabilized and could not get any worse. QBE share price is not pricing in any material uplift in investment income and we feel this could surprise on the upside in the medium term.
- QBE being a global insurer has majority of its earning sourced from around the globe. A weak Australian dollar exchange rate against USD and EURAUD will continue support earnings. As the AUD is a risk on currency. Any material improvement in Australian dollar could be driven by improving global economic fundamentals which will be followed by equity markets and interest rates. However improvement is not our base case.
The company reduced dividend significantly and raised capital number of times after the GFC to reduce debt on the balance sheet.
Future earning power and dividend payout will be dependent on continue operation improvement. Investment income improvement will be icing on the cake.
Key risk we see for QBE is the Australia Mortgage Lender Insurance business line. The business has been extremely profitable and makes up a large portion of the Australian net profit. However the LMI business is a feast and famine business where it is highly leveraged to the residential real estate cycle.
Australia house prices has been in a secular bull market for more than a decade. As we noted in our Sydney property market forecast, there is significant leverage in the system. Leverage has matched the increase house prices where the record run in price increases has resulted in no deleverage by households.
If there is any slowdown in Australia house prices, QBE domestic earnings will be hit and it would be another stumbling block in its path to profitability. A drastic slow down in housing driven by unemployment is a long tail event in our forecast, however we would not be surprised if earnings are downgraded again if there is a housing slowdown in its home market.
Chart shows the return year to date of all major listed insurers. QBE and IAG are the largest 2 property and casualty line insurers. AMP is a life insurer and SUN strategy is to integrate insurance and banking into one.