QBE – becoming shipshape?

QBE (ASX: QBE) has announced an update on its ambitiously named Global Operational Transformation Program. The two major targets are:

  • Reducing the costs of doing business, largely by transferring low margin/high value activities (call centres, basic processing, etc.) to wholly owned offshore entities. Savings of around $230 million are expected by the end of 2015.
  • Strengthening the balance sheet via capital management initiatives (partly undertaken), sales of non-core assets and lowering the dividend payout ratio. A debt-to-equity ratio of less than 40% is expected by the end of calendar 2013.

QBE also confirmed that investment earnings are expected to remain in the range of 2.25% for the current year. On this, it is important to note the company is no Berkshire Hathaway and has kept little exposure to equities in recent years. Therefore shareholders cannot expect any ‘windfall’ value gain from the rise in US and other stock markets. QBE’s investment earnings are almost purely dependent on the direction of interest rates.

QBE has had a history (until recently) of strong operational management and enviable insurance margins. However, a simple case of too many acquisitions has led to the usual indigestion, especially in the US operations. With the Americas accounting for over 50% of QBE’s premium income, firm action here is a requisite for any substantive profit improvement.

A recent Macquarie report on QBE, in part comparing QBE to Ace Insurance (NYSE: ACE), highlights the dramatic operational impact of too much, too soon in the way of acquisitions.

Underwriting expense ratio is a core and vital measure of insurance company performance (the lower the ratio, the better). Since commencing major acquisitions in the US (2006), QBE’s US underwriting expense ratio has climbed from 8.2% to 21.5% in 2012. Clearly not sustainable! In the same period, the Ace Insurance underwriting expense ratio has moved from a comparable 8.8% (2006) to 11.8% in 2012.  Although no two companies are directly compatible on all measures QBE and ACE have very similar profiles.

In Europe QBE’s underwriting expense ratio is 15% and in Australia 16% — in line with or slightly better than most competitors. More needs to be done here too.

Foolish takeaway

QBE has coped with many storms in the past and none of the present problems are insurmountable. It is a quality company with resourceful management experience and skills. Does the current price (around $16) justify an investment? At anticipated 2014 earnings of $1.30, the P/E ratio would be 12.3, and the largely unfranked dividend yield 4%. However these raw figures underplay the potential should economic and insurance conditions stabilise or improve over the next few years. In this Fool’s opinion, QBE will remain a solid investment for the medium to long term.

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Motley Fool contributor Peter Andersen owns shares in QBE.

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