Monday, 28 July 2014

QBE - Is it still a buy?

QBE has again issued a profit warning prior to announcing its mid year result in August. This time its Latin America business in Argentina having issues with revision to reserve strengthening by 170M plus changes to discount rate adversely impacting the result by 120M (non-cash) excld Argentina. This has brought down Combine Ratio (COR) from 93% to 96-97% and insurance profit down from 10% to 8%.

Amidst these continued downward profit revision since mid 2013, one must keep the holistic view of the company as a premier insurance underwriter in the industry. Not many insurer can match the QBE underwriting standards with consistent COR in 90's. The business is still profitable. Good news is that North American business which had problem last year is improving and management is happy with the progress. QBE also has cost reduction initiative in place which will reduce cost overtime, taking effect from 2015.

Whilst valuing insurer on the basis of earning could be difficult given revision to reserve estimates, inclusion and exclusion of non-cash and non-recurring items could change profitability year-over-year;  however, book value and float remains stable. Herein lies an opportunity, with $16-17 of float, QBE is trading at 40% discount to its cost-free float, which relatively and historically is quite cheap. Comparative profitable insurer on average trades above float or atleast at the value of float. Other good news is the investment yield is rising up from 2.5% to 2.7%. QBE is also leveraged to increase in interest rate in US.

In nutshell, QBE will fix these issues. In 2 year, QBE will have higher investment income, continue to have profitable underwriting, and increase it's value of float. I expect QBE to trade atleast at the value of the float which is about $16-$17.