What is the stock?
QBE Insurance Group, a back to the future opportunity.
How long have you held the stock?
We have owned QBE in the portfolio for about a year.
What do you like about it?
We seek to buy superior quality stocks with a sensible risk buffer and hold those investments so that the longer-term advantages of these companies manifest in a superior rate of return. These superior companies are characterised by great management, who are committed to shareholders, operate in a growing market, and have a long-term competitive advantage.
Our investment process is designed to identify those stocks that have the most characteristics of a superior company, whilst also offering a valuation edge. An initial investment in such a company is accompanied by an Energy argument, which incorporates evidence (a Trigger) that a material change (for example, in a company’s growth profile), is manifesting in support of our investment thesis about the company.
Energy Argument for QBE – QBE historically were able to roll-up niche insurance businesses where they had some advantage in pricing insurance risk. All of that changed after buying Winterthur in the US. This, along with a change of management, seemed to have resulted in a loss of that advantage. We believe that a simplified more focussed company provides a great back-to-the-future opportunity to improve risk outcomes and returns to shareholders.
Trigger – Having previously spent three years as CFO, and successfully rectifying problems in 2017 as Australia and New Zealand division CEO, Pat Regan was the natural replacement for the outgoing CEO. He has started his tenure with a methodical approach, reviewing the entire business and subsequently selling its troublesome Latin America division for a $100 million profit above book value. The company is beginning the process of change that we have been waiting for, opening the opportunity for a change in earnings growth.
How is it better than its competitors?
QBE operates in the global insurance market and has historically been able to find niches where they were able to profitably underwrite insurance risk. Rather than being exposed to just one market, like their Australian peers where the insurance cycle is arguably at relative highs, QBE’s exposure to multiple niche insurance markets allows it to diversify by geography and business type. The benefits of the restructuring program should provide a tail wind that the competitors do not have.
What do you like about its management?
We believe the CEO’s methodical approach, implementing what the company calls its “Brilliant Basics” strategy to ensure excellence in underwriting, pricing and claims, will deliver a sustainable turnaround in the business. Pat Regan was able to improve the profitability of the Australian division in the 18 months he was in charge and he has spent the year since his appointment as group CEO building the senior leadership team he believes will help grow the business. Pat Regan has also continued the simplification of QBE – not just selling out of Latin America, but selling out of certain underperforming parts of Asia, and putting up the uncompetitive US personal lines business for sale.
What is your target price?
The near term price target is $13.50, which is 1.5 times book value. Competitors Suncorp and Insurance Australia Group trade at 1.5 and 2.5 times book value respectively.
At what point would you sell it?
We sell stocks when our energy argument to be in the stock has been invalidated or we believe the stock is trading at our target price, and we can find more attractive opportunities to invest.
How much has it added (subtracted) to your overall portfolio over the last 12 months?
It has added approximately 0.3% to our performance this year.
Where do you see the value?
While the initial trigger to invest in QBE was new management’s focus on simplifying the business, there are a number of potential tailwinds that could also benefit company earnings in the next few years. Firstly, the core underwriting business profitability will be helped by improved insurance premiums, as 2017 was the worst year of natural disasters since Hurricane Katrina in 2005. Secondly, the US Fed expects to raise interest rates a minimum three times in 2018, making the $26 billion short duration fixed interest investment book a major beneficiary of this interest rate tail wind. With the company trading at around 1.2 times book value, we see minimal downside from here, with the opportunity of much larger upside, should our energy argument be confirmed.
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