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- RBA’s Bullock gives a hint towards near-term interest rate relief
- QBE 3Q trading update reveals a lack of catastrophes – should be similar for its share price!
- Emeco – recent trading commentary suggests that cash is king of their focus
The Market
The week: ASX and Wall Street
FYTD: ASX and Wall Street
RBA’s Bullock delivers a hint of good news for households in 2025
Investment Matters has noted over the years that markets for the past two decades have spent considerable time and resources parsing in detail small changes in statements made by central banks around the globe.
Central banks understand this focus. And in turn are very careful with their language in both written statements and press conferences. The aim is to be clear, hold surprises to a minimum and use their status to influence markets expectations in a consistent fashion.
Markets appreciate understanding which economic factors are being considered more closely than others.
So, within the context of careful language, and a 12-month period in which RBA official interest rates have remained unchanged, this week’s change of language provided markets with increased confidence that interest rates will fall in 2025.
The RBA Board gained “some confidence” that “inflationary pressures are declining in line with these recent forecasts” and “moving sustainably towards target” and believe “Some of the upside risks to inflation appear to have eased.”
The Board continues to appear determined to break the back of inflation before reducing interest rates, despite the economy appearing soft in parts and weakening further in recent periods.
Prior to Thursday’s unemployment data, but post RBA discussion, markets priced around a 65% probability of a rate cut in February.
Governor Bullock’s press conference acknowledged that some recent data on the real economy has been soft and that the Board’s views are evolving. She also noted faster than expected moderation in wages growth.
With lower expected inflation and moderate wages growth the opportunity for multiple rate cuts in 2025 are increasing – given the RBA is gaining confidence in lower medium-term inflation.
Market economist (Barrenjoey, in orange) is now forecasting lower inflation that the RBA’s view from November (black)
Source: RBA and Barrenjoey Research
First Samuel’s view is that the case for rate cuts beginning in February has already been made. The reasons include
- Australia is already suffering a private sector recession – only the government is growing (shown below with overall economy in orange and private sector in black) and;
- the need for Australia’s economy to accept inflation at the top end of the RBA range (towards 3%) rather than striving for very low inflation. Higher inflation and lower rates allow the younger generation capacity to bear the burden of historically high levels of debt without suffering from intergenerational disadvantage.
GDP growth is the weakest since the 1990s recession and the private sector is shrinking
Source: ABS National Accounts and Barrenjoey Research
Despite the softening conditions, the part of the economy that appears stronger than expected for rate cuts remains the unemployment rate and employment growth in general. Yesterday saw a surprise rise in total employment, a reduction in the unemployment rate but weaker growth in hours worked.
We suspect unemployment is a red herring. Massive population growth and the low productivity gig / health services economy is driving an increase in jobs, but those jobs are not receiving strong wages growth, nor are they particularly productive. New Australians are finding jobs, few people are losing jobs from current positions, and younger people are finding opportunities.
But the employment growth is simply covering population growth since 2023, as this excellent chart from Barrenjoey shows. The vertical bars are showing employment growth in total percentage terms, and the components of growth attract a different colour. Green is new growth in jobs from people entering the workforce from not looking for work, and orange is the change in unemployment. Blue is simply new people arriving (either to Australia, or to the labour force for the first time) and getting jobs.
Employment growth, per cent year-on-year, by source (population growth, unemployment changes and changes in participation)
So, we are not surprised that employment growth in weak productivity jobs is continuing to perform despite zero private sector growth and struggling households. They are poor jobs. Growing better jobs requires strong structural demand led growth that will be enabled by lower rates and a long- awaited increase in business investment.
QBE – catastrophe free
QBE has been a core holding in clients’ Australian shares sub-portfolios and has generally occupied a role as a larger financial services exposure alongside Macquarie Group.
We have been attracted to the diversity of revenues, the global focus of earnings capacity and the fundamental attractive valuation.
However, given the broad nature of its business lines, volatility of global weather patterns, and swings in investment markets (from which reserves and capital are invested), owners of QBE can often face a nervous wait as end of calendar/fiscal year end approaches!
This year, QBE’s recent Q3 update delivered a relatively clean bill of health from the three key swing-factor risks they are exposed to, being:
- the Florida hurricane season;
- their Crop insurance business; and
- investment earnings volatility.
QBE has remained a large position in clients’ Australian shares sub-portfolios for a number of years.
Overall, the past five years (to 12 December 2024), the QBE share price has generated a return of 66%, more than 15% higher than the ASX300 returns (including dividends).
Clients’ accounts have benefited from trading the stock around its valuation and generated total returns of more than 78% over the five-year period. In short, QBE has been a great position, but it always remains a stock over which your investment team remains cautious when it reports its short-term operating results.
The update at the end of November was pleasing.
2% YTD growth in Gross Written Premium (GWP) – top-line growth is better than it may seem
QBE reported +2% gross written premium (GWP) growth on the prior corresponding period in 3Q24 in both reported and constant currency terms. While at first glance, 2% growth appears modest and is slightly below the 3% which the company has forecast (and around which consensus analyst expectations sit) for the full year (end December),
- Excluding portfolio exits, Group gross written premium increased by 5%, or 9% on also excluding crop insurance premiums.
- Premium rate increases at the Group level were +4.9% in 3Q24, below the +6.7% achieved in 1H24 and +8.9% in 2H23 and below the +9.6% in the previous corresponding period (pcp). In North America, premium rate increases were +6.4%, below +9.3% in 1H24 and +10.0% in 2H23 and below the +12.3% in pcp.
- International reported a +2.5% premium rate increase in the quarter, slowing from +4.8% in 1H24 and +5.5% in 2H23 and +6.0% in 3Q23.
- In Australia Pacific, the average premium rate increase was +7.3% in 3Q24, down from +9.9% in 1H24 and +13.2% in 2H23 and 12.5% in pcp.
Company guidance remains at 3% for the FY24 period too.
FY24E GWP growth remains at 3% but is 2% YTD
Source : Company data, UBS
But clearly, there is a moderation in premium growth rates around the globe after a period of above-average premium increases, particularly in 2023.
Moderating growth in premium rate rises
Source Company Data, UBS
Swing factor 1 – Hurricanes and other catastrophes – within allowance
QBE has received US$425m of catastrophe claims in the four months to end of October, with an allowance of almost US$700m provided for in the half. This likely leaves adequate room for November and December, which are seasonally quieter months in terms of the impact of the major US hurricane season, which is the largest weather-driven insurance market in the world.
FY24E CAT outlook is unchanged – headroom for Nov/Dec
Source: Company Data, UBS
Swing factor 2 – Crop – better than previous years, but not as good as hoped
Crop is a specialist area of insurance. In essence, QBE and other insurers provide an ‘income protection’ style of insurance to reinforce agricultural producer incomes against poor crop conditions such as hail, drought, fire or chemical overspray.
While there had been some optimism in markets about the outlook for the agricultural insurance market and a better-than-average year, so far, claims and returns have proven to be in line with historical averages, albeit better than the challenges of FY22-23.
FY24E Crop Combined Operating Ratio of 94% – better than FY22/23 but above target
Source: Company Data, UBS
Swing factor 3 – Investment earnings
While key underwriting drivers are tracking in-line, QBE’s investment income outlook is stronger, reflecting:
- higher fixed income running yields of 4.4% at 22-Nov-24 vs the 3Q average ~4.25%, and
- higher investment assets, up 9.5% over 3Q to $33.4bn , reflecting FX and pre-funding of debt replacement.
Takeover candidate?
In a contrast with Australia’s domestic general insurance players such as IAG and SUN, which trade at relatively full PE multiples compared to their international peer set, QBE is trading on a forward Price Earnings multiple of ~11x, which is below international peers. It is also a ~40% discount to other stocks in the Australian share market.
US commercial lines insurers, such as Chubb and AIG, trade on 13-14x. With a relatively low AUD/USD exchange rate, QBE looks vulnerable to offers from offshore insurance peers.
It really does appear undemanding when compared to some of the Australian banks, which offer lower returns on equity, have had declining absolute earnings and yet are trading on prospective PE multiples of more than 20x earnings in some cases.
QBE is trading at a larger than usual valuation discount to the market
Source: Factset, UBS
Price Earnings (PE) multiple and PE relative to the ASX200 – a steep discount
Source: Factset, UBS
Emeco – a lift in cashflow
Is cash the king of Emeco’s focus? It looks like it.
In late November, Emeco Holdings provided a trading update to coincide with the company’s Annual General Meeting.
The company note the following operating conditions in 1H25:
- Increasing Return on Capital (ROC), which implies strong utilisation and targeted profit margins
- Sectors previously seeing revenue weakness are now expected to see equipment deployed in the 2H of FY25
- Underground rental utilisation also improved with Emeco awarded new gold and base metal contracts.
- The company is reaffirming its operating EBITDA of at least $300m, noting that overhead cost reductions previously outlined are now being achieved.
The early FY25 combination of activity, cost savings, and only moderate stay-in-business (SIB) capital expenditures provides a strong base for exceptional free cash flow.
Previous years have seen disappointing unrestricted free cash flows. In some years, there has been leakage in cash flow to growth capex; other years saw lower margins generate less cash. There has been a period in which resizing weak segments of the business has drained cash and, on one occasion, bad debts from a collapsed client wrecked otherwise strong performance.
Six months into FY25, few excuses stand between EHL shareholders and unrestricted free cash of up to 15 cents per share. This level of cash earnings would provide the company with a range of balance sheet, dividend, and growth options.
The company’s share price was already trading at a discount to net tangible assets, implying weak cash generation capacity. At a PE of less than 8 times FY25 earnings, the market was also wary of its capacity to grow in future years.
This update helped clarify both uncertainties and the stock has reacted strongly over the past month, rising from around 76 cents per share prior to the AGM to a high of 93-94 cents this week.
We were pleased to see this improvement in operations for EHL, as the position is an important one in most clients’ Australian shares sub-portfolios. This is because it provides cheap access to a key sector of the economy and stock market: the mining services sector. Clients also own other exposures, including Imdex, SGH (Caterpillar WA), Mineral Resources and a new position in Develop Global (DVP).
All these companies have strong tailwinds coming from rising production volumes. Mining services is an important sector because, unlike direct mining, where profitability is a function of the specific mine’s costs versus a global selling price, mining services are generally paid for the volume of ore mined, the time the equipment is used, the value specialised equipment creates.
In its AGM presentation, Emeco provided a handy chart showing the breadth of mining volume growth expected in 2025 and 2026, according to official industry figures.
In 2026, the volume of coal, gold, and iron ore mined is expected to grow strongly.
Australian Mine Production outlook, million tonnes
The tailwinds of volume growth are clear but turning that demand into higher returns on capital is the harder part of the management task.
It is pleasing that in November, barely five months into operation, the company was confident that the ROC target of 18% rising to 20% is achievable. Should EHL create such returns, the stock could trade closer to $1.20 per share and generate attractive and sustainable dividends.
Proving up the potential of FY25 over the next eight months will be vital.
With the stock now at levels higher than purchase prices and approaching our valuation we will use strength to lighten should the stock approach higher levels,
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advice.