huntey's recommendation from etrade

Heading: Model not broken - Patience required.


Huntley's Recommendation: QBE Insurance Group Limited
Recommendation: Buy



Fair value reduces from $27.55 to $26.40 and price triggers adjust accordingly.


QBE is one of the best managed insurance groups in the global general insurance and reinsurance industry. An enviable track record of strong earnings with a minor blemish following the events of September 11, 2001 is testament to a first class business model and conservatism. Extensive risk management is in place to protect all stakeholders.

Throughout QBE diversification is used to reduce the overall risk profile by spreading exposures by product and geography.

Overlaying fundamental procedures and strategies is a level of prudence providing significant comfort. A growth strategy based on the combination of organic growth and insightful acquisitions has and should deliver well above average growth in earnings and dividends. QBE is an excellent stock for inclusion in long term growth portfolios.

The mid-June market update from London confirmed an insurance profit margin of 16%-18% for FY10. We expected 1H10 earnings to be at the bottom of the range due to soft revenue growth, higher claims costs and lower investment returns. Management expected investment returns to be slightly higher than the FY10 guidance of 3%, despite lower than expected returns in 1H10. Despite the assurance the share price continued to under perform over the past six weeks. The Market Update of 26 July starkly provides the reason. 1H10 NPAT is expected to be 40% below 1H09 levels of A$1.018bn suggesting a figure in the range A$600 - $620m. QBE decided to adopt the US$ as the presentation currency from 2010 as it is more relevant in measuring performance. Around 75% of QBE business is written in 48 overseas countries and over 50% of annual premium is derived in US$.

Business Impact: While very disappointing importantly there is nothing wrong with the underlying insurance business model which is reflected in a combined operating ratio of 89.7% and a solid insurance margin. The dominating factor causing the 40% slide in 1H NPAT is a US$414m fall in gross investment income from US$558m to US$144m.

The lower investment income is due to lower interest yields, lower foreign exchange gains, lower one-off gains and the decline in equity markets which increased the level of realised and unrealised losses in the equity portfolio. We reiterate our confidence in the medium to long term. Movements in investment income are generally short term in nature and QBEs income will recover with global investment markets and interest rates. QBEs investment portfolio is over US$20bn of which some 90% is held in cash and investment grade short term fixed interest securities. Our FY10 NPAT estimate reduces from $1.87bn to $1.66bn. EPS declines from 180.7� to 160.4� using weighted average shares of 1,035m. FY11 NPAT forecast reduces from $1.92bn to $1.84bn with EPS falling from 183.7� to 176.1� using weighted average shares of 1,045m. No change to our DPS estimates of 130� and 132� respectively. Fair value reduces from $27.55 to $26.40 and price triggers adjust accordingly.