Investment Matters

A big week of reporting

Company profit reporting season reached its apex this week, with six companies in your Australian Equities Portfolio releasing results.

So far this reporting season nine companies in your portfolio have released their financial reports; the share price of eight of these stocks have outperformed the market in the period since release.

Your portfolio has benefited significantly.

We have been pleased with the individual performance at the company level, as well how each company has demonstrated through its operations, the strength of our underlying thesis.

IMgraph returns

QBE

QBE delivered what was another strong full-year result for FY-19 (its reports its full-year result on a calendar year basis).

The headline figures were as follows:

  • An adjusted cash profit of US$733m – a 6% increase compared to FY-18
  • A combined operating ratio^ (COR) of 97.5% - compared to 95.7% in FY-18
  • Gross written premiums of US$13.4m – compared to $13.6m in FY-18

Performance reflected:

Pricing: the ability to institute price increases while retaining business.

  • The company was able to institute price increases across its portfolio of 8.3% in the second half of FY-19 (relative to an increase of 4.6% in 1H-18). Furthermore, in the fourth quarter, the company was able to institute an average price increase of 9.2%. while maintaining strong retention (which was largely stable for the year).

Investment performance

  • The company achieved a net investment return of 4.6%. While 1% of this was attributable to a decline in rates (which have a particularly pronounced impact on its fixed income portfolio), the return excluding rates was 3.6% - above their targeted range of 3%-3.5%.

Profitable underwriting/underwriting performance

  • QBE’s COR was higher than its guided target range (94.5-96.5%), the result was impacted by several large claims related to natural disasters and weather-related events – namely a poor crop season in the US as well as changes in prior year claims.
  • Importantly, the attritional claims ratio, that is the ratio of claims of a value of less than US$2.5m as a percentage of net premium earned (i.e. excluding large and catastrophe claims – which can be sporadic and skew results) has continued to trend downwards, declining from 50.2% in FY18 to 47.5% in FY-19. This is a reflection of the underwriting improvements the business has made as part of its cell reviews and ‘Brilliant Basics’ program.

Cost control

  • The company’s total expenses have continued to decline, from $1,793M in FY-18 (an expense ratio of 15.62%) to $1,690M in FY-19 (expense ratio of 14.6%).

For FY-20, the company has guided towards a COR of 93.5%-95.5% and an investment return of 2.5-3.0%. Furthermore, with the consolidation of the company’s portfolio is now largely complete, it is looking to grow organically.

***

Emeco

Emeco’s result was largely in line with its recent market update.

It was, however, well received by the market, with shares in the company rising significantly over the week. Accompanying the financial results, investors including ourselves welcomed the strong message provided by management on many fronts;

  • clear details on the strategic rationale of its recent acquisition
  • clarity on operational improvements including utilisation
  • confidence regarding debt refinancing  
  • clear explanations relating to working capital movements, and;
  • critically - management’s confidence in hitting key performance targets

Operating profit (EBITDA) for the half year was $119.1m, an increase of 16% on the prior year. This was reflective of higher operating utilisation (that is, actual operating hours the rented fleet is operated as a percentage of Emeco’s target average of 400 operating hours per month) and the contribution from its growth assets.

Overall operating utilisation was 65%, an improvement on the prior year.

Operating utilisation in Eastern Australia (NSW and QLD) remains high at 69.2%. Operating profit in the region grew from $98m to $105.4m predominantly as a result of its recently acquired growth assets and increased utilisation.

The company over the half relocated its equipment from Eastern Australia (predominantly NSW) to Western Australia. In doing so it deployed its equipment to growing iron ore and gold projects in the region and has diversified its commodity exposure.

Operating utilisation in the western region was 42%, an increased from 40.8% in the prior period. As a result, operating profit to $24.2m, up from $22.1m. The company expects utilisation to continue to improve in the second half which will flow through to higher operating profit levels. Furthermore, margins should improve as lower margin projects are completed. 

What was notable was that the company highlighted operating profit from Pit N Portal (proposed acquisition) is likely to grow in FY20 and FY21 at a rate of 15%. This growth had previously not been quantified and represents an addition of approximately $3m in earnings per annum. Furthermore, the company highlighted that it is renewing existing contracts and entering new contracts on 3-5 year terms, indicating tightness in the market.

The company re-iterated that it is on track to reduce its leverage to 1.5x (Net Debt/EBITDA) in FY-20 and 1.0x in FY-21. As part of this process, it will look to re-finance its existing notes.

***

Southern Cross Media

Southern Cross Media’s result reflected a challenging half for the advertising market.  This weakness however was well understood by the market, and the lack of any further deterioration saw the stock price rise significantly.

Revenue for the half was $301.1m*, 8.2% lower than the previous comparative half (1H-19). This was largely reflective of a broader contraction in the advertising market over the half.

What was notable was that regional advertising revenue was relatively resilient, particularly as the company is pursuing advertising growth in regional Australia. In line with this strategy, the company completed its acquisition of Redwave Media over the period (Seven West Media’s regional radio assets) which will bring an additional $2m in operating earnings (EBITDA) in the second half of the year.

Despite lower revenue driving a 28% decline in underlying operating profit (EBITDA) the company reiterated its focus on reducing its cost base, having completed a review of its operating and capital cost base over the first half.

Southern Cross has declared an interim dividend of 2.75 cps (vs 3.75 cps in 1H-19). 

***

Boral

Boral’s result for 1H-20 was in line with its recent market update.

The company reported a headline operating profit (EBITDA) of US$440m* vs US$470m in the previous year (pre-AASB, excluding the impact of the Windows business and excluding the now sold Midland Brick Business).

Boral Australia was impacted by lower revenue in concrete and building products, as well as outages at its Peppertree Quarry and Berrima Cement operations.

Boral North America saw an increase in fly ash volumes and prices; however, this was offset by several one-off costs as well as cost increases (largely higher fly ash costs).

USG Boral (Boral’s plasterboard business) was largely stable with earnings growth in China and higher earnings in Thailand offset by activity declines in Korea and Australia.

The company expects operating profit for FY-20 to be below FY-19, however, its assets leave it well-positioned in the medium term.

***

Carbon Revolution

Carbon Revolution continued to ramp up its production over the half, producing almost 7000 wheels.

This translated to revenue of $20m over the period, which the company sees rapidly increasing in the second half. This will be driven by the deployment of new equipment that will drive operational efficiencies and throughput.

The company remains confident it will achieve its prospectus outlook of 23,000 wheel sales and $62m in revenue in FY-20 and expects to be operating profit positive (EBITDA) in the fourth quarter of FY-20.

***

Origin Energy

Origin’s result was largely in line with expectations.

As a reminder, Origin operates two primary business units: Integrated Gas (primarily its 37.5% stake in APLNG) and Energy Markets (gas and electricity retailing/wholesaling).

Underlying net profit was $528m for the half, which was down from $592m in the previous half.

This was largely due to a reduction in the profitability of Energy Markets. Energy Markets delivered an underlying operating profit (EBITDA) of $723m, down 15% on the previous year. This reflected the impact of a period of transition, with the implementation of default electricity pricing (regulatory change) and one-off events in the form of unplanned outages. The company continues to focus on reducing its cost to serve to offset the impact of these changes (down 13% or $28m over the period – with $100m in total savings targeted).

Underlying operating profit (EBITDA) from its share of APLNG was $906m – largely stable in comparison to the previous year (1H-19) with lower domestic gas sales offset by higher sale LNG volumes.

Origin has declared an interim dividend of 15 cents per share in the half (up from 10 cents per share), reflecting its improved debt position and cash generation. This was at the mid-point of its guided range (39% of free cash flow vs target of 30-50%).

The company maintained its full year guidance of an underlying operating profit of $1,400m to $1,500m. This would represent an 8% decline on the previous year - largely reflecting the impacts of the electricity pricing transition and outages in the first half.

 

^COR is sum of the net claim’s ratio, commission ratio and expense ratio. These represent the total costs of insurance as a percentage of the net earned premium – or premium it has earned after reinsurance.  A combined operating ratio below 100% indicates profitable underwriting results (with the company earning the difference). A combined operating ratio over 100% indicates unprofitable underwriting results.
*Pre-AASB16 accounting changes – which brought operating leases on balance sheet and reclassified lease expenses as an interest and depreciation expense (rather than an operating expense).