QBE - FY12 results review

QBE released their FY12 results (to 31 December 2012) last week. Despite the negative headlines in the press, the results were a perfect example of “good for debtholders but bad for shareholders”.

The FY12 profit was slightly weaker than QBE's revised expectations (i.e. profit warning) from 12 November 2012 and market consensus estimates with net profit after tax of US$761m (FY11 US$704m) and a cash profit of US$1,042m (FY11 US$791m).

While the equity market was disappointed with the result and future guidance, this was still a 32% increase in cash profit from FY11 and considered a relatively good result from a debtholder perspective.

Key aspects of the results release included the following:

• Net profit after tax up 8% to US$761m
• Cash profit up 32% to US$1,042m
• Gross premium revenue up 1% to US$18.4bn
• Higher than normal natural catastrophe payouts, including those related to Hurricane Sandy, and poor performance at its U.S. businesses were the biggest drag on earnings. Total “large losses and natural catastrophe claims” were $1,643m, although that was better than anticipated in the November 2012 profit warning
• Combined operating ratio (i.e. incurred losses and expenses relative to earned premiums; the lower the ratio the better), up to 97.1% versus 96.8% for FY11
• Net investment income saw a significant improvement, up 57% on the previous year to US$1.2bn and a net investment return of 4.1% (versus FY11 of 2.9%). This was supported by a large increase in realised and unrealised capital gains of US$504m (versus FY11of US$181m)
• The company raised more than US$1bn in capital through shares and convertible debt securities over the past year. Importantly for debtholders, capitalisation levels have improved significantly year on year with the minimum capital ratio (MCR) of 1.7x at 31 December 2012 versus 1.5x a year earlier. From a creditworthiness perspective, this was the main feature of the results and provides a material increase in the equity buffer below debtholders
• A reduction in dividends (final dividend of 10c per share versus 25c a year earlier) and forecast future dividend payout ratio revised from 70% to below 50%. Once again a material positive for debtholders at the expense of shareholders
• The company has also commenced a cost saving program that aims to cut US$250m per annum from its cost base within three years, including a number of job cuts/moving roles to Manila. However, the details on how this is to be achieved were scant with further announcements to the market likely in coming months
• The company highlighted that US$1.1bn of hybrids and subordinated debt is due for call in 2013

New CEO, John Neal, said the "disappointing" result was due to the impact of lower earnings from QBE's U.S. business, from where it gets roughly a third of its income. He also announced a raft of changes in senior management and that the company’s strategy of aggressive acquisition lead growth is on hold “we are not planning more acquisitions during the year. The focus is on the core business''.

Once again these decisions are viewed as good for debtholders in that risk is reduced but are generally seen as negative for earnings and share price growth.

QBE do not have any AUD bonds in the market but there are a number of subordinated bonds and Tier 1 hybrid securities in non-AUD, mainly USD, which we believe exhibit strong relative value (available to wholesale clients only).

We remain comfortable with the credit and call risk of the “old style” QBE step-up securities and expect QBE to continue to call at first opportunity (subject to regulatory approval and market conditions at the time of first call date).

For further information on the available non-AUD QBE securities, please contact your dealer or call 1800 01 01 81.