Earnings season will always be a rollercoaster ride for any share investor. Companies dust off their ledgers and unveil skeletons they've been hiding in their books all year, making for some volatility in the short-term. The lead-up to earnings season often provides some interesting disclosures, however this pre-earnings season has been uncannily quiet, making me think we're in for a good run on the S&P/ASX 200 (ASX: XJO). One stock I think will surprise on the upside is global insurer QBE Insurance Group Ltd (ASX: QBE).
A changed company
QBE has had a torrid five years, issuing four profit downgrades in that time. Most of these were considered "legacy issues" remaining from ex-management, but now that CEO John Neal has held the top job for three years, it appears that most of the downgrades are over. Since taking on the role, Mr Neal has strengthened the balance sheet with large capital raisings, several cost-cutting measures and more recently, completing the sale of its North America Mortgage & Lending Service for $100 million in order to reduce debt. This sale follows the decision to withhold the sale of its lender's mortgage insurance arm (LMI) because of poor sentiment in the LMI market, demonstrating the principled rationalisation undertaken at QBE.
The discipline shown by new management suggests QBE is no longer its old self and so perceived cobwebs appear to be weighing on its share price, with the stock trading at a modest price-to-earnings ratio of 14.6. This compares to the average P/E of 19 under old management, which in my opinion, makes the stock historically cheap.
American outlook
The kicker for QBE comes from the structure of its insurance businesses; although QBE is Australia's largest insurer, almost 65% of its earnings are derived from its American and Latin American operations. Given the lack of natural disasters in the last 12 months and the increased economic activity in the U.S., QBE's American operations should perform well in constant currency, with insurance margins set to grow by 8.5-10%. When translated from USD, the 10% decline in the AUD since January should boost earnings as well.
Given QBE reinvests its earnings in U.S. government bonds, an increase in rates by the Federal Reserve (which is first expected to occur in September this year) should see QBE materially benefit from its reinvestments as well. This should be positive for earnings, indicating the downgrade cycle may be over and that the company is set to enter an earnings growth phase.
Foolish takeaway
With strong momentum across all of its businesses, new management and the bulk of profit downgrades behind it, I believe QBE will deliver solid earnings this reporting season, making it a good buy at current prices. Although it is not the cheapest stock on the market, QBE's international exposure and economic outlook in those areas should, in my opinion, provide a boost to earnings and see it as one of the better performing stocks this earnings season.
