Stock Story: QBE Insurance

Airlie Funds Management

April 2023

Quality management and strong cycle leading business turnaround.

QBE is a global commercial insurance provider. The stock is a position we first added to the portfolio in September 2022. This is a company that for a long period had failed to pass almost every step in our process - business quality, financial strength, management quality and valuation. The impetus to revisit the stock was twofold - we liked the medium-term outlook for insurance pricing and the company announced the appointment of a new CEO with a fantastic reputation, Andrew Horton.

Insurance pricing is cyclical and alternates between periods of soft and hard market conditions. Several years of above-trend catastrophe events (CATs), as well as covid-related business interruption claims and the return of broad-based inflation, has seen the commercial insurance market tighten considerably. The net has been a prolonged period of premium rate growth not seen since the early 2000s. The cycle looks poised to continue (albeit at a lower rate of growth) as insurers digest and push through the impact of reinsurance rate increases, and continue to price for an inflationary environment. (refer to the premium rate change chart over time at the end).
QBE specifically has spent much of the past decade trying to digest an untethered period of acquisition spending that took place under former CEO Frank O'Halloran. Insurance is ultimately a people business and acquiring a range of large and small businesses all over the globe in a short period meant QBE lost track of the quality and exposure of its underwriting. The issues were particularly acute in North America, where the combined operating ratio of the region has remained above 100% for much of the past ten years. However, despite some of the headline results, there have been incremental signs that the underlying quality of QBE's business has been improving - divestment of underperforming exposures, poaching quality underwriting teams and transactions to de-risk reserves.

QBE's calendar year 2022 result arguably represented the first reporting period in which investors could plainly see the improved operating performance of the business. Gross written premiums (GWP) grew 13%, inclusive of an average group-wide renewal rate increase of 8%. The company reported GWP growth of 13% constant currency and an underlying combined operating ratio (COR) of 93.7%. Pleasingly, QBE's North American division reported a COR of 98.9%, the division's first profitable result since 2018. The result in North America came despite a weaker-than-average year in the crop insurance business and is consistent with management's focus on portfolio remediation in property programs and growing the retail business to drive scale benefits. At a group level, cost discipline and operating leverage (in a strong rate environment) saw a material improvement in the company's expense ratio, from 13.3% to 12.4%. CATs came in line with November guidance, albeit ~$100m (10%) higher than the original FY22 allowance. QBE reported a 4.1% running yield for the fixed income portfolio to end the period, which is clearly a material tailwind for FY23 (and will support QBE's expectations of a mid-teen ROE). QBE's regulatory capital ratio increased from 1.75x to 1.79x, with debt to total capital reducing from 24.1% to 23.4%, the lowest level in over a decade.
We continue to believe QBE is underearning as margins for both the  North  American  business  unit  (sub-scale, bad underwriting), and more recently the Lloyd's syndicates (pandemic business interruption, catastrophes), have dragged on group performance. Industry pricing trends remain favourable, which should drive positive operating leverage, and the recent step-change in investment portfolio yields (as cash rates have lifted rapidly around the world) should see return on equity remain comfortably in the double digits on a three-year view. To date Andrew Horton has demonstrated a sensible approach to growth and risk management, and for all of these reasons QBE still looks attractive to us at ~9.5x P/E.

Source: company filings
 

Author: Joe Wright, Senior Investment Analyst

Funds operated by this manager:

Airlie Australian Share Fund

Important Information: Units in the fund(s) referred to herein are issued by Magellan Asset Management Limited (ABN 31 120 593 946, AFS Licence No. 304 301) trading as Airlie Funds Management ('Airlie') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation. This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon.

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Equitable Investors

April 2023

US households supporting flows to equities despite recession risk

Source: Barclays Research

Money Supply (M2) has high correlation with S&P 500

Source: GLJ Research

Global central bank liquidity has been increasing according to Citi Research

Source: Citi Research, Bloomberg

2023 shaping up as the second best year for dip-buying strategy

 

Source: Bloomberg

Global equity capital raisings by quarter ($US)

Source: WSJ, dealogic

Australasia equity capital raisings by quarter ($US)

Source: WSJ, dealogic

US VC deal activity in aerospace and defence technology

 

Source: WSJ, PitchBook

US bank deposits

 

Source: Reuters

Trading Margins on ASX Listed Debt and Hybrid Sectors (27 Mar)

 

Source: Bell Potter Research

US Two-Year Bond Yield - Four Week Average Daily Move

Source: Bespoke Investment Group

ICE BofAML MOVE Index (US bond market implied volatility)

Source: FT, Refinitiv

Top 10 Nasdaq 100 components = 55% weighting

Source: Equitable Investors, SlickCharts

Top 10 S&P 500 components = 27% weighting

Source: Equitable Investors, SlickCharts

Top 10 iShares Core S&P/ASX 200 ETF components = 46% weighting

Source: Equitable Investors, Iress

S&P 500 performance without "big tech"

Source: eToro, Bloomberg

April Edition

Funds operated by this manager:

Equitable Investors Dragonfly Fund

Disclaimer

Nothing in this blog constitutes investment advice - or advice in any other field. Neither the information, commentary or any opinion contained in this blog constitutes a solicitation or offer by Equitable Investors Pty Ltd (Equitable Investors) or its affiliates to buy or sell any securities or other financial instruments. Nor shall any such security be offered or sold to any person in any jurisdiction in which such offer, solicitation, purchase, or sale would be unlawful under the securities laws of such jurisdiction.

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Hedge Clippings | 28 April 2023

Economic Cross Winds

Following last week's release of the Review of the Reserve Bank, which targeted the RBA's culture, management and performance, the focus now returns to next week's board meeting, and the potential for an extension of the policy pause announced in March. Supporters of this view - by no means unanimous - were encouraged by this week's inflation figure which saw annual inflation to the end of March fall to 7.0%, down from December's 30 year peak of 7.8%.

Others saw it differently, particularly those who pointed out that inflation at 7% is still at least 4% above the top of the RBA's target range of 2-3%, and are wary of the inflationary effects of wages policy, plus any inflationary impact from the Government's first budget, due on Tuesday week. Thereafter it is going to be more difficult for Chalmers to blame Scomo (a.k.a. Minister for Everything) and Josh Frydenburg for Australia's inflationary and economic woes, when the root cause of the current situation was global or external.

Our call is for a continuation of the pause, even if only for a month until the budget is out of the way and the picture is clearer. However, barring a recession, expectations are for inflation to remain elevated for longer than the RBA expects, so it is likely to be well into 2024 or beyond before Australia's inflation rate starts with a "2", by which time, if Jim Chalmers has anything to do with it, Philip Lowe will be long gone.

Turning to the US, there is also a Fed meeting scheduled for next week, with the Federal Reserve chairman Jerome Powell facing further economic cross winds as core inflation picked up in the March quarter, while growth was just 1.1%, well under the median forecast of 1.9%. Higher inflation, coupled with lower growth, is not a positive formula, particularly while the Fed is also grappling with falling confidence in the banking system as San Francisco based First Republic Bank suffered withdrawals of 40% of its deposits in the first three months of the year.

Coming on the back of the collapse of US banks Silicon Valley and Signature, and the Swiss National Bank's emergency liquidity of US $120 billion to support the UBS absorption of Credit Suisse the risk of contagion in the US and the global banking system is heightened.  This article from the Economist Intelligence Unit - although a few weeks old - argues that financial contagion is unlikely. However, if consumers or depositors' confidence is shaken by the chance of their loss of capital, this could change very rapidly.

News & Insights

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Investment Perspectives: Banks, balance sheets and bailouts | Quay Global Investors

March 2023 Performance News

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Australian Secure Capital Fund - Market Update March

Australian Secure Capital Fund

April 2023

Funds operated by this manager:

ASCF High Yield Fund, ASCF Premium Capital Fund, ASCF Select Income Fund

Regnan: Investors are still not

getting the ESG disclosures they need

Pendal

March 2023

Companies are increasingly disclosing their exposure to climate risks. But those disclosures often do not give the investors the full picture. Regnan's ALISON EWINGS explains

• Climate disclosures too narrow

• System-wide effects of climate change often ignored

IT'S been five years since the Task Force on Climate-related Financial Disclosures began trialling voluntary, consistent climate-related financial risk disclosures for use by companies.

While take-up has been good, investors still need to see a lot of improvement in ESG-related disclosures, says Alison Ewings, who engages with ASX-listed companies for sustainable leader Regnan.

About 80 per cent of big global companies now disclosed in line with at least one of the taskforce's 11 recommendations.

But most companies are still taking too narrow a view of climate risks and failing to consider the underlying, system-wide interdependencies and economics risks of climate change that will impact their operations, says Ewings.

A Regnan assessment of disclosures shows they are often narrow in scope and place climate transition risks ahead of considering system-wide interdependencies and different potential economic scenarios.

Regnan is a leader in sustainable investing and an affiliate of Pendal.

Regnan's Head "Look at what's happened in Australia lately -- fire, fire, flood, flood, flood -- everyone who's dependent on the Australian economy has been affected by those things," says Ewings.

"But when you look at an individual company you see 'well we're fine'. But you're not fine. You're not an island. You're part of the broader economy.

"We think about this as an additional risk that climate change is going to add for every business.

"Some businesses are more leveraged to economic activity than others, so they're more exposed, but they're all exposed to some extent.

"So instead of saying there's no climate risk, internally we talk about it as there being a background level of risk that is not nil.

"This is something that's not being explicitly considered by companies in their TCFD disclosures and we're not sure that it's really being explicitly considered by investors, insurers and banks."

Five underlying climate risks for investors

Ewings says underlying climate risk can take five main forms.

First, general consumer behaviour will likely change as temperatures rise and extreme weather events become more common.

This could include changing preferences for food, clothing and holiday destinations, to the need to rebuild after natural disasters or even relocate for more favourable climatic conditions.

Second, businesses are all reliant in some way on the underlying infrastructure around them, from roads, telecommunications and power to access to water. Changes to the availability of infrastructure can have profound implications for a business's operations.

Third, disruptions in supply chains due to extreme weather, shifting demand or interrupted transportation.

Fourth, businesses rely on the resilience of the communities they operate in to maintain their workforce and customer base.

Assessing the health of the community should form part of a business's risk assessment.

And finally, with extreme weather no longer an infrequent, temporary phenomenon, overall economic growth is likely to be lower.

Businesses should reflect this base level reduction in demand in their planning.

"The key thing is the interdependency," says Ewings.

"Once you get outside of your organisational boundary, that's where things start to fall apart.

"For instance, companies do a good job of site-by-site analysis of the impacts of climate change to physical locations.

"But it is very rare to see consideration of the infrastructure on which they also rely on like the transport networks that move things to and from those sites.

"It's rare to see anything about the resilience of the communities in which their employees work -- it might well be that your factory is fine, but nobody can get there or nobody's feeling like coming to work.

"All of these factors should be considered."

Author: Alison Ewings, Head of Engagement

Funds operated by this manager:

This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com