QBE delivers but the banks disappoint

Week two of the August reporting period saw QBE (ASX:QBE) deliver a strong first half result that suggests upside in both valuation and earnings, with strong top line momentum and above-inflation premium rises a feature.

The big banks in CBA (ASX:CBA) and NAB (ASX:NAB) didn't quite deliver, however, with cost pressures a thematic that are likely to play out over the next 1-2 years across the sector. Net Interest Margins, though, are set to expand in the coming quarter as Australia's banks take full advantage of RBA rate hikes.

But the biggest news this week may well have come from a company which is yet to report, with BHP's (ASX:BHP) stunning $8.3bn takeover offer for Oz Minerals' (ASX:OZL) rejected outright. Is there merit in a combination? Is a higher offer in the works?

I discuss this and more in episode two of the August 2022 4-Minute Monday podcast.

Transcript

Stewart Harris: Hi and welcome to episode two of 4-Minute Monday for the August 2022 reporting season. Joining me to share his latest thoughts is Brad Potter, Tyndall’s Head of Australian Equities. Morning Brad, and thanks for joining us.

In our last episode you flagged QBE (ASX:QBE) as one company to watch. First half earnings were down but the insurer’s guidance was well received by the market. How did you see their result?

Brad Potter: The QBE result is often a flip of the coin. However going into this result, as I commented last week, our expectation was it would be pretty good given the positive signs we were seeing from their international peers. And thankfully QBE didn't disappoint, with its first underwriting profit ex-crop insurance in the USA since 2014, which was a strong positive. In the operating line, gross written profit was extraordinarily strong at 18% growth in the first half and guidance of 10% growth does really look quite conservative given that first half lead. 

Therefore, the combination of strong top line momentum combined with these above-inflation premium rises that we're seeing, together with the much higher investment yields that they're generating is pointing to upgrades in both valuation and earnings for the company.

Stewart: Thanks Brad. Turning to the banks, we had updates last week from both CBA and NAB that broadly met market expectations, but how did you see the two results?

Brad: Both CBA (ASX:CBA) and NAB (ASX:NAB) had slightly disappointing results for companies that are trading at such high premiums, especially CBA which is arguably one of the most expensive banks in the world. Albeit for both banks the bottom line was probably okay. Unlike ANZ (ASX:ANZ) we’re yet to see any material net interest margin expansion. This is likely to emerge in this quarter, as the banks take full advantage of the RBA rate rises. Both banks performed poorly on the day, which was probably indicative of the market’s expectations. 

Pressures on costs remain, and this is really expected to continue for the next one to two years and is a sector-wide issue. 

Asset quality remains pristine, and both banks continue to write back excess provisions that they took during the 2020 COVID situation. All the banks have excess COVID provisions that they’re writing back gradually over time. There still remains little stress in the mortgage book, and this is unlikely to be an issue unless unemployment rises substantially. So overall, over the next 12 months at least, banks have a net interest margin tailwind and, when combined with few bad debt issues, earnings should be reasonably strong.

Stewart: Brad, somewhat on the periphery to reporting season, but one of the biggest developments last week was BHP’s bid for the Oz Minerals (ASX:OZL) business, which saw the Oz Minerals share price skyrocket and trade above the offer price of $25 a share. Were you taken aback by the bid, or do you see merit in a combination?

Brad: Apparently, BHP and OZ Minerals were negotiating an offtake agreement for OZ Minerals’ West Musgrave nickel asset in WA, and BHP eventually came back with this $25 cash offer that OZ has subsequently rejected. The sense of the deal is quite compelling, as OZ Minerals has two primary assets that can be integrated into the existing BHP operations, and therefore there's substantial savings available in transportation, refining, and smelting given the utilisation of BHP's existing processing infrastructure that is nearby. OZ Minerals requires substantial capital to develop the West Musgrave deposit in WA and BHP certainly has the balance sheet, so that helps alleviate any issues from that. 

The OZ Minerals assets are primarily copper and nickel, which are certainly vital for this large global decarbonisation trend that we're seeing. The market at the moment is currently pricing in BHP upping the $25 bid. However, I don't really think it's necessarily a fait accompli.

Stewart: Thanks Brad. Lastly for this week, what’s front of mind for you and your team as we move into week three?

Brad: The third week of reporting season really starts to hot up, with plenty of companies reporting. The BHP result would have been of keen interest in the context of any capital management, however with the OZ Minerals bid it is now unlikely to see much in the way of higher dividends until we get clarity on whether that bid is successful or not. The Santos result will hopefully provide some further clarity on their asset sell downs and the excess cash flows from selling some LNG cargos into this stratospheric spot market. Outside of these two, there are a number of industrial companies such as Brambles, Amcor, Downer, and James Hardie that certainly will help us get a bottom-up reading of both the local and global economies.

Stewart: That’s two weeks down and two to go. Tune in next Monday for the third instalment. But until then, stay invested.

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