(TUESDAY 17TH JANUARY- 07:37- JAMES GERRISH)...The US MKT was closed overnight however European mkts were higher (FTSE up +0.37%, German DAX up +1.25%, French CAC up +0.89%) while locally, the SPI FUTURES mkt is pricing a higher open up +9pts when trading kicks off here this morning.
OVERSEAS MKTS; The main focus overnight was on European Bond yields after the downgrade on Friday and auctions for French and Spanish Debt. Yields were actually lower which was a positive and probably shows a higher amount of ECB participation in the mkt. Whatever the case, S&P is probably sitting back with some significant concerns about their lack of influence in the mkts these days. The reality is though that a rating is a relative score against other mkt participants so when we get more participants with lower ratings, the less impact a rating downgrade will actually have. Supporting that thesis was the lack of mkt concern when we saw the European Bailout Fund downgraded from AAA to AA+ which really was a surprise given Germany is the only participant still rated AAA.
Looking at the Auctions, France got away €1.895bn of 12-month bills at a yield of 0.406%, down from the 0.456% they paid only a week or so ago. The 3-month and 6-month paper (over €8bn in total) was also given at lower yields.
Other European Bond Yields fell other than Italian 10 year debt which was pretty flat.
German 10 year Yields
French 10 year yields
Italian 10 year yields
COMMODITIES; For a full list of overnight prices, CLICK HERE
Copper continued higher overnight, Gold was up a touch and the broader suite of a base metals pretty much all finished higher. There was no floor trading in the US so obviously volumes were light but the action shows that investors didn't expect the downgrades to have any impact on global growth.
OUR MKT; Will be focussed on Chinese Growth data out today which generally gets released around lunch time. We're expecting growth of 8.7% which would be the slowest pace in 10 quarters and will support some easing of Chinese policy (Reserve Requirement Ratio cuts).
We also get RIO + FMGs production reports today.
QBE Insurance (QBE)
QBE came out with a shocker last week saying profit would fall by 40-50% due to higher payouts from natural disasters. The stock fell sharply on the news but I think its worth a look at these levels for those that don't own it - while those that do could consider adding to existing positions.
What Happened:
QBE said their net result is likely show a 40 to 50% fall in FY11 NPAT to between US$640m and US$765m from US$1.278bn in FY10. A small loss may be reported for 2H after 1H NPAT of US$673m. The final dividend will be cut from 66 to 25 per share with the FY11 DPS falling from 128 to 87. What ever way you slice and dice it, it was a pretty poor number and we saw investors dump the stock.
I guess the question to ask now is whether QBE's recent performance is the new norm or its just a blip in an otherwise strong track record.
QBE's Business
Firstly I think its critical to understand how the business operates. It's a company that has diversified geographically and across a huge number of sectors to provide insurance. It's in the business of pricing risk and has done a pretty good job of it over many years.
When you're in the business of pricing risk, of putting numbers around natural disasters you'll get it wrong on occasions and profitability will be hit. That's what happened here. They ineffectively priced risk and are paying the price for it.
After pricing the risk, they issue an Insurance Policy and the customer pays the premium. QBE then invests that premium in the Bond mkt to generate additional returns.
Investment returns have been under intense pressure as the chart below shows because of ultra low interest rates in the US impacting Bond Yields. This is another area of concern for QBE at the moment.
So with the mispricing of risk and the ultra low interest rates impacting investment returns, not to mention the high Aussie Dollar, earnings have suffered and the earnings trend looks pretty poor.
Will this theme continue or can the company turn things around?
When we see a period of higher than usual catastrophes, we then see premiums increase on the back of it. It gives the company an excuse to do it while their pricing models have a new round of data to consider. So from a revenue perspective, it seems that QBE will be able to increase that side of the ledger in the years to come.
When it comes to investment returns, you need to have a view on US interest rates. Will they go lower or higher? Looking at a chart of the US 10 year Treasury we see they are currently sitting at 1.86% while the benchmark rates are sitting at 0-0.25%. Thats fairly low and I'd probably make the argument that they're more likely to go up in time than go down. If they go up, it will have another positive impact on QBEs earnings.
Book Value = Assets - Liabilities. What they would get if they wound up the business now and sold off the parts.
In 2007 when the market was powering, QBE traded at nearly 4 times its book value. At that time, the stock was trading above $35 whilst book value was calculated at $9.63.
At the moment, the stock is trading at just 1.06 times book value which is calculated to be $9.68. At this level it seems the stock is being priced for these current conditions to remain. It doesn't consider that insurance is cyclical in nature and periods of earnings contraction are often followed by period of earnings expansion.
The chart below shows the relationship of price to book value and share price while the brown bars cover the dividend. You can clearly see that QBE has not been this cheap when considering price to book for many years and although its likely to be a long road back for the insurer, there is a fair amount of clarity around how they can turn earnings around.
Analysts expect the following: Our FY12 NPAT forecast reduces from US$1.865bn to US$1.665bn and from A$1.78bn to A$1.586bn on an A$/US$ exchange rate of 1.05. EPS falls from 157.1 to 140.3.
We anticipate a rebound in DPS from 87 to 120. Fair value eases from $21.10 to $19.65 and price triggers adjust accordingly. While disappointing it is not the end of the world. That did not stop the share price falling 20%. Another opportunity!
So i'd be happy to ad to QBE here. I've owned the stock prior to the drop so if I was happy to buy it at $14 & $13 - I'm happy to weigh in at $10 & $11 based on the above thesis.
AUSTRALIAN DUAL LISTED STOCKS
US mkts were closed
James Gerrish
