Qualitas Controladora SAB de CV

BMV:Q

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, and welcome to Quálitas Fourth Quarter Results Webcast. Quálitas team will review the company's financial and operational performance for the quarter and the past 12 months, provide a summary of recent events and answer any questions that you might have. If you have trouble to visualize the presentation, you can also find this document in the Quálitas IR website. If you continue with such trouble, please contact Violeta Ruiz. Her contact is being currently displayed.

Information discussed on today's call may include forward-looking statements regarding the company's results and prospects, which are subject to risks and uncertainties. Actual results may differ materially from what is discussed here today. The company cautions not to place undue reliance on these forward-looking statements. Quálitas undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

The conference will now begin.

[Jose Correa Etchegaray, executive]

Thank you. Good morning, and welcome, everyone. Thank you for joining us for the conference on the fourth quarter and the report for the 2018 results. In this conference, we will review the financial and nonfinancial results of the company for the fourth quarter and the year, and we will be opening the line for questions that you may have.

As you know, another year has come to an end, and we learned many lessons about our operations and how to keep getting better but also with some improvement that have led us to present these results today. At this time, we will talk about relevant topics to Quálitas, such as the overall landscape, the strategy and results, the stock performance, the multiples profitability, solvency margin, and we will also be discussing our guidance for 2019.

As you know, this company's strength is given by its people and its structure. So before getting to the financial figures, I would like to briefly remind you of our company's structure integrated by our facilities but, more importantly, by our organization. Quálitas has more than 5,000 employees, out of which 1,200 are claims officers and over 400 are lawyers. We also come with a support of almost 14,000 independent agents to distribute our products. We have over 400 offices located in 4 different countries, and to provide the best service and faster repair time, we also work with more than 3,500 workshops. We have the largest network and market share in terms of written premiums and service coverage in Mexico. And as you know, we also have operations in the U.S., Costa Rica and El Salvador.

During this year, we faced some complicated moments in Mexico. For example, the sale of new cars suffered a decrease of 7.1% versus 2017, and I want to highlight that almost 70% are purchased with credit. How those -- this has influence on Quálitas? Well, the financial institutions that are the ones granting credit when buying a car represent more than 35% of the total underwriting for the company. The first quarter of the year, Quálitas premiums written show a slight decrease, but during the year, we changed and we wanted to improve profitability on those businesses, which required us to adjust pricing up. This also required increased focus on the sale of policies rather traditional selling, which is promoted by agents.

In the upper-right of the graph, we show the theft and recovery of the insurance industry in Mexico. As you can see, car theft rose by almost 3% during 2018 and car recovery show an increase of 6%. We've seen the effect to the entire industry. Quálitas represents 33% of it and the recovery shows that we have a better rate, representing almost 36% of the total industry's recovery. In Quálitas, various measures have been implemented to prevent car theft, such as the use of tracking devices and the study of risk routes and hours, the physical inspection of vehicles to prevent fraud among others.

In the lower-left graph, you can see the relation between the cost that can affect Quálitas at the time of a claim. According to INEGI, the cost of spare parts, the price of the vehicle and the exchange rate are directly correlated. Within the claims cost of the company, collision coverage has more weight. It represented more than 35% of the claims cost in 2019, followed by third-party liability with more than 25% and theft with 20%. As we have shared in the past, the company has a strict cost control philosophy and it always seeks to have the lowest repair cost possible without sacrificing quality and good service for our policyholders. The company is vertically integrated as there are supplies that are part of the organizational structure. Importantly, agreements with medical suppliers and having an in-house legal structure has proven to be a key for cost control. These measures have helped us to reduce average cost per claim for the medical and legal expenses coverages. To improve service and to shorten response time, the company implemented chat bots late last year, beginning the implementation of artificial intelligence tools that, in the end, will help improve service to our customers and will also reduce costs.

Let's move to Slide 6. One of the reasons why we continue to be market leaders is because of our strong fundamentals and the profound belief in our philosophy. As I have mentioned, some of our cost control measures within our operations have led us to post 94.6% adjusted combined ratio that also translated into a 5.5% underwriting margin that compares favorably to the 2.7% reported in 2017. These figures show our understanding of the industry and our high adaptability to the environment. At the end of the year, we had 3.9 million insured units in the 4 countries where we operate. We offer more than 30 different coverages that features all the clients' needs, and we are very close to our policyholders and agents to hear their suggestions and needs in order to be able to adjust to those needs. We also invest in technology and we have around 13 different projects to improve our operations and grant a faster and better service. To reach these, we have -- also have service offices near our customers and clients and in-house client structure. The main goal of these efforts is to have a company that is sustainable over time with long-term relationships with all our stakeholders.

On this slide, we can see a positive trend in our results. Premium written show a 3-year compound annual growth rate of 20%. The premiums earned 23.1%, and the comprehensive financial income show 27.3%. Underwriting result and also the net result show a solid outcome. The cash per share show a strong 25.9% 3-year compound annual growth rate. We will further expand on each of these highlights in the following slides.

Let's go now through our cost ratios. The combined ratio show an improvement on a quarterly and cumulative basis versus 2017. Let's review them one by one to understand why the combined ratios stand at that level. Let's do the acquisition rate first. For both periods, the acquisition cost show a significant improvement of almost 2 percentage points due to the decrease in the commission paid to financial institutions that drove this cost to decrease. The written premiums grew 2.5% and 1.7%, respectively. The claims ratio also show a decrease compared to last year despite the growth in claims cost by 3.7% and 9.7% that was compensated by stronger boost in premiums earned in both periods. Quálitas is constantly searching for new alternatives to control costs. The operating ratio show an increase versus both periods of 2017. First, I will explain the basics. The operating expense figures were above prior year. They show an increase of 40% in the quarter and 83% on a cumulative basis, mainly explained by 1 million time benefit -- I mean, the $134 million one-time benefit in 2017 for there is movement of premiums by a reinsurance company, and during 2018, higher fixed paid to office representatives and employee profit sharing. The premiums written advanced 2% in both periods.

On this slide, you can see the income statement and balance sheet with the main accounts. First come the written premiums that increased by 2.1% during the quarter. That was a real challenge if we consider that new car sales decreased by 7.2% over the period. The underwriting result grew 69% despite an increase in operating expenses. This result led to an underwriting margin of 9.2% that compares favorably with a 5.8% previously reported.

Now on the slide that we are showing, I would like to look at the understanding -- underwriting result that was more than double to the one reported in 2017, resulting in an underwriting margin of 5.5%, as we have mentioned. The integral financing result decreased by almost MXN 112 million, mainly explained by a lower return of our investments. As I have also mentioned before, the cost control is vital for the company, and learning to do it correctly derives in good results. The net result show an increase of 17.7%, resulting in a net margin of 7.6%, and the adjusted combined ratio was 94.6%. We are pleased with the return on equity for 2018, which was 28.5%, and that is well above our going target of having our return on equity of between 18% and 24%.

I would like to show now the breakdown of premiums written on this slide. Please note that the breakdown only includes figures for the Mexican subsidiary, which, as I mentioned before, represents about 95% of the total underwriting. As you can see, financial institutions had a decrease in underwriting during the year. The traditional segments, fleet and individual, grew double-digit during 2018, more than compensated for the shortfall in financial institutions. These shows the strength of our underlying business. The segment that you can see there as classified as other is primarily integrated by toll roads, and this year, we lost concessions to certain toll roads in the country. But the second that I also want to highlight is the ODQs. They show an increase above 23%. They are highly profitable and also help us bring our insurance products to places where there wasn't one, giving us a competitive advantage in the distribution of our products and services. I also would like to share with you, according to AMIS, that the -- if the ODQs were an independent business, they would rank in the 19th position out of 34 automobile insurance companies in Mexico.

On this slide, you can see the underwriting of the group. Individual and fleets combined show an increase of 18%, and this segment helped us achieve the 2% growth in premiums written during the year. Financial institutions continued to decrease due to a slowdown in new car sales and high interest rates that hinder people from buying new cars. Regarding the subsidiaries growth in dollars, El Salvador show a growth of 8.6%, Quálitas Insurance Company show a softer increase slightly over -- around 1%, and our subsidiary in Costa Rica decreased sales by 3.9%. If you take a look at the mix of premiums by duration, you will notice how we shifted towards more annual policies, and these policies help us to be more flexible of adjusting tariffs as necessary. As of December 2018, almost 70% of the insured units in the Mexican subsidiary had a duration below 12 months. The units with multi-annual policies represented more than 30% of the total premiums, and the majority of these policies have a duration between 1 and 5 years.

The next slide shows the breakdown of our investment portfolio. The portfolio has a 43% share in short-term investments to take advantage of current interest rate levels. As of December, 17% of our portfolio was invested in equities. Our portfolio is mainly focused in Mexican small and mid-caps but generating long-term value, and it is worth noting that we have an internal limit of 35% to invest in this type of instruments. The return on investments for the year was 4.6%. Our investment portfolio show a defensive position as we've had positive return significantly above of the Mexican Bolsa or the IPC Index performance that by December 31 had a negative return of 15.6%. The float shows a compounded annual growth rate above 24%.

On this slide, we compare Quálitas performance relative to the market, and you can see the positive trend and stable performance of the stock for 2018. Since March of the year, we are considered high marketability stock. Q* trades an average daily value of USD 1.5 million. We are part of 2 important indexes, the Dow Jones Sustainability Index and the FTSE BIVA of the new stock exchange in Mexico.

I don't want to spend much time on this slide, but I just wanted to note the good 12 months performance of the stock. As you can see, Q*'s performance was the best among financial institutions listed.

Take a look at the positive trends of Quálitas, and this is why I continue to feel confident that we'll have a great capacity to generate value. The stock price shows a compounded annual growth rate of 24% over the period. All these are very important, but what really amazes me is that the net result of the year versus the same period of 2015 represents an increase of more than 300%, while the price has increased 91% for the same period.

I believe the company has mainly -- one main purpose: to create value. And to illustrate it, on this slide, we present the cash per share and the book value. Cash per share for 2018 is MXN 66.52, a compound annual growth rate of 21.6%, and book value showed an increase of 21% and is at MXN 20.93. During the year, as you also are aware, we distributed a cash dividend of MXN 0.70 per share, and we canceled 15 million repurchased shares that used to represent 3.3% of capital.

Now we will review the capital requirements and the consolidated solvency margin. The regulatory capital requirement totaled MXN 3,634 million at the end of the year, and the solvency margin was MXN 4,585 million, an excess of our target. That represents a ratio of 2.26 of what was required. Quálitas has always been characterized not only by its discipline and efficiency but being conservative to be able to cover all of our liabilities. Clearly, we will be discussing with our board the dividends to be recommended through a shareholders' meeting to be held in the second quarter once the audited financial statements are final.

On the following slide, let me show you the guidance approved by the board on our yesterday's meeting. We are estimating an increase in written premiums between 5% and 7% mainly due to our expectation of a continuing slowdown of new car sales for this year but also based on estimates of growth brought by the higher enforceability of Mandatory Insurance; and earned premiums growth between 7% and 9%, a figure higher than increasing written premiums. We are foreseeing a combined ratio between 93% and 97%. The breakdown of this ratio is an acquisition between 22% and 24%, a range of 68% to 69% for claims ratio, and finally, between 3% and 4% of operating ratio. We are also forecasting an operating margin between 3% and 4%. And for the financial side of the business, we think we can have a return on investment of the annual average of Banxico's interest rate plus MXN 320 million to MXN 350 million of financial surcharge. Nowadays, this rate stands at 8.25%, and we are considering a float between MXN 29 billion and MXN 30 billion. It is worth mentioning that this guidance may vary due to macroeconomic conditions.

Now we are glad with the results obtained by our organization in a year that was characterized with uncertainties, and we are very optimistic looking forward and prepared for emerging challenges. I want to thank you all for listening. It was really a pleasure to present you Quálitas results for this 2018.

Now I would like to answer questions that you may have. Operator, could you please now open the line for Q&A session?

[Operator]

[Operator Instructions] We do have a question. The first question comes from Ernesto Gabilondo.

[Ernesto María Gabilondo Márquez, analyst]

Jose Antonio, 3 questions on my side. The first one is on your expectations for premiums growth. I believe your guidance is not including the implementation of the Mandatory Insurance. So how much do you think it will be adding in the medium term? What are you planning to help the authorities for its implementation? My second question is on your 2019 guidance. We have incorporated it in our estimates and we are obtaining a net income growth of 10%. So I just want to know if this growth is reasonable to your expectations. And where are you seeing the sustainable ROE? And finally is regarding the performance of the investment portfolio. We saw a weak performance of it in the last quarter due to the market volatility. However, interest rates are at 8.25%, and I think with a premium surcharge, the yield for 2019 is likely to be around 9%. So why don't you reduce the equity exposure of the portfolio and assign more weight to fixed instruments related to Cetes or TIIE? I believe you would like to have long-term equity positions. However, they have not been paying enough in the last couple of years. So I believe that investing at TIIE or Cetes will help you to obtain the 2019 guidance at the very low risk while reducing market volatility. All your thoughts will be really appreciated.

[Jose Correa Etchegaray, executive]

Thank you for your questions, Ernesto. It's always a pleasure to talk to you. First, about the expectations on Mandatory Insurance. As you know, in Mexico, we have had Mandatory Insurance since 2014, 2015. It has been increasing gradually, but what we have seen is that it is not something that is really relevant in -- I mean, sizable in terms of our results. Now it is true that there might be some upside there. We don't know how much that could be and it will be a matter of understanding how it is going to be enforced. Our experience in the past has been that insurance has been limited. I mean, the coverages have been low. So we will see how this develops, and certainly, this could help to have a little bit more of a premium regarding Mandatory Insurance. But the experience of the past 3 years tells us just to be prudent, and we cannot necessarily count on a big impact of that in our numbers, no? Now let me go now with your second question regarding the 2019 guidance and the -- let me tell you -- I'll start probably with the growth in the premiums written. Here, we continue to see, as we see the numbers of the industry, the industry expects still a year in which the things that I have seen include that there is going to be probably a continued reduction versus 2018, small one, probably around 4% or so, which we have built into our estimates, no? But the rest of our businesses, as I mentioned, during the -- or that wasn't in -- on the slides, we are confident in our fleets and our individual businesses, which have grown nicely over the past year. We continue to focus on those. So we think that, that is going to be something that is going to be good. Now in terms of your question of -- on the growth and sustainable ROE, profit and net income growth, certainly, you could argue that the 3% and 4% might be a little bit conservative. We need to consider that the environment, general environment in the world, I would say, and in Mexico in particular is going to be a year with uncertainties. There are a number of things that need to be sorted out on the macro level. What happens with the trade war between China and the U.S. will have impact in the economy. Clearly, we have a new government in Mexico. So we are being cautious about that but we feel that, that is a good level. Let me tell you about the sustainability of the ROE. We believe, and as you can say, clearly, the 28.5% that we have shown probably is -- well, not probably -- is above of what has been our target between 18% and 24%. I'm confident that we will continue very likely to achieve that. And it is important to note that as we saw in the solvency margin and the excess solvency that we have that at some point in time, we will be, this year, considering that -- within our dividend policy to distribute dividends. The amount -- and also to cancel repurchased stock. How much of that is going to be still need to be defined and to be recommended both to the board and to the shareholder meetings, but I'm confident that as -- in this year, we have a profit per share growth of 21.7%, which was very good. That will continue pushing or will be the -- what is going to take us to have an ROE within the target that we have set. So yes, I think that the ROE is sustainable at the targets that we have set in our -- for Quálitas. And now let me talk a bit about the investment portfolio. The investment portfolio, you mentioned about changing and probably switching part of the equities into fixed income. It is important to note that we have reduced the level that we have. As you might recall, we used to have close to 27% of the portfolio in equities. We closed the year with around 17%. We are not planning really to increase. I know that the interest rate level that we have are good, as you have mentioned. And what's going to happen with the rates? Well, it will depend on how inflation in Mexico behaves. There were talk that they will continue to increase now that the threat is now -- is not going to have as many rate increase as they said. Probably, we are not going to be pushed in Mexico to increase the rates either. And there have been talk even, as you probably have heard, that they might even go down depending on the inflation behavior. Now I think that the level that we have, I think it is about right, what we have seen, based on what we can see on the macroeconomic level. And we will consider, if we are not going to be able to reach the returns on equity, to see if we need to change. But so far, we are not planning to sell more of that. It will be done. As we have seen, the returns of our equity has been good over the past 5 years or so, has been much more than the benchmark indexes. So it's something that we need probably to consider, but we are not necessarily taking a view that we need to unload those positions as [ we'll keep ]. Now I hope that this answers your question, Ernesto.

[Ernesto María Gabilondo Márquez, analyst]

Yes, yes, Jose Antonio. So follow-ups, the first one on your 2019 guidance. So is it reasonable to expect that the earnings growth of 10% this year based on a technical margin of 3%, 4% and better investment results? And then just let me add another question regarding to the appointment of your new CFO. Can you share with us his background and experience and experience in the industry?

[Jose Correa Etchegaray, executive]

Of course, Ernesto. Let me tell you that I'm very, very, very glad that we have Bernardo joining us now to Quálitas. We just today had his appointment approved by the board. The board is very confident on his skills and abilities and experiences. He's going to be a very good addition to the Quálitas team. I'm sure of that. I have no doubt about that. Let me tell you that he has a lot of experience in many countries. He has been working in the finance area in many capacities in many countries, I mean, in the U.S., in Panama, Venezuela, in Brazil and Chile, and he has what it takes to help us here in Mexico to add more value to our business. I don't have any doubts about that. Now regarding insurance, he might not have all the experience, but we have given him training and onboarding, which have been very, very intensive. And considering his abilities, he -- I'm sure that he will pick up that very, very quickly, obviously. We have -- all the directors of the company are with him, rallying him. And so the full immersion that he is having to our business will make sure that will be a significant contributor going forward. I'm very confident that he will continue, as I said, building value for our shareholders. Actually, what I hope is that you all have a chance to meet him personally because that will -- clearly will help you understand what are his skills, his experiences, but as I have mentioned, I guess for the third time, that he will be a very good addition to our company going forward.

[Ernesto María Gabilondo Márquez, analyst]

And just to follow up on the 2019 guidance. So is it reasonable to expect net earnings growth of 10% this year?

[Jose Correa Etchegaray, executive]

Yes, yes, I mean, it is a range. I think that might be probably a bit conservative, if you will. We are ending the year -- or we ended the year 2018 with strong position in terms of cost control. So we -- I am very confident that the position we are starting is good. So it might be -- I think along this range, it is a good guidance. So that's the one that we discussed with the board, and they feel confident about it, too.

[Operator]

We do have another question. The next question comes from Gilberto Garcia.

[Gilberto Garcia, analyst]

Can you comment on the potential risk of your strategy to focus more on the agent channel? Could this result in increased pricing pressure of -- I guess consumers have more options to shop around. And could -- do you think this could result also in more volatile results given that you will have fewer policies written the years prior to smoothen out the short-term results?

[Jose Correa Etchegaray, executive]

Gilberto, thank you for your question. Let me tell you that the reduction in the financial institutions is not really a decision about necessarily to reduce the level of financial institutions. It really has come up as a result of us adjusting the right premiums for that channel. There were some institutions that were pushing Quálitas to provide lower premiums. Clearly, what we want is to have -- as you know, the company strategy is to have low cost so we can offer lower premiums and that we can be profitable. Now as -- being a market leader, it is really difficult because our competition really positions normally below Quálitas. So financial institutions wanted us to keep lower levels and what we said is, "No, we want to have a good business with you. We want to be partners with you." We are partners with them, and we want to make sure that we are profitable. So we had to take the rates up, and that's the reason primarily of why we have decreased in financial institutions. Clearly, and as I mentioned before, the -- you saw in the graph that there has been lower sales in Mexico each and every of the months that we're showing for 2018. So it is a combination of that, that has provided the results of going down in this channel. Now having said that, the strength of our business and the things that Quálitas has been doing that gives me also confidence is really to see that the individual lines, which is the thing that is distributed all over the country, this optimization of our business has grown 25 -- 21.6%. I mean, that is really very good in our view, and that is the result precisely of how strong is our brand and the value that we provide to our customers. I've been traveling throughout the country. And while in the past, you might -- I mean, several years, well, you might say that Quálitas might be expensive, et cetera. In the ones I have been visiting -- and I mean, many, many cities, that is not a concern. So the strength of the brand continues to be there. We have some pricing power to make sure that we price the products right. So this 21.6% in individual growth, I don't think that it's going to be a problem. How is it going to go about the financial institutions? Well, we will see how the economy behaves in 2019, but I'm confident that our position with the individual and also with the fleets -- and the fleets are -- really like us, have been -- last year, we lost one big account, one fleet. And this year, we have it back. I mean, they want to return to us because of the service that we provide. So I'm confident that we are going to be able to continue having a nice growth in that area, Gilberto.

[Operator]

[Operator Instructions] We have no further questions.

[Unknown Executive]

We have a couple of questions in the webcast. So the first one is by, I think, [ Arturo Espinola ]. Why was there a higher duration of research related to multi-annual policies in previous periods?

[Jose Correa Etchegaray, executive]

[ Arturo ], well, you know that multi-annual policies require -- because of the length of the [ manifest ]. So it is not that we had -- we haven't necessarily [ limited ] research on that one. It has been the normal actuarial procedure of those policies. What we have seen though is that more than the reserves itself, which is good, our models are valuated. And by the way, I want to say that we are continuing to working with specialization that we have in Quálitas that we continue to fine-tune our models. And probably, we will be the -- early this year, we are going to be also making improvements to our models, obviously, with the regulators' authorization, et cetera before we do that, no? But in this case, what we are seeing is that the [ ODI ], so the commission that we paid to financial institutions which are mostly related to these multi-annual policies, have reduced the acquisition cost that we have and that has helped us also in regard of this -- of the index of the acquisition index. But that's something that -- there's nothing special on that regard.

[Unknown Executive]

And then the second question comes from [ Oliver Leyland ] from [ Fiera Capital ]. Can you please comment on the pricing environment and competitive pressure considering both the weaker car sales and higher interest rates?

[Jose Correa Etchegaray, executive]

[ Oliver ], thank you for your question. Well, the pricing environment is -- well, clearly, it's going to be -- one of the interesting things in the insurance business is that there is some uncertainty, no? The global -- there is uncertainty. In Mexico, with the new government, there is some uncertainty. But interestingly enough, these periods of uncertainty tend to be good for insurance. People want to protect their assets, and that's something that we consider here in the case of the automobile insurance in Mexico. So we think that, first, clearly, the environment, as always, will continue to be competitive. We are -- as I mentioned in the answer before, regarding the growth in individual, in our individual business, our individual business has grown very -- or has shown a very healthy growth. We have been able to put the pricing that we believe it is the right one. As you know, we don't want to be -- I mean, we want to have the combined index between 93% and 97%. This is what we are targeting. We don't want to get -- I don't know how to say it, but we don't want to be too eager to increase that, no? We want to make sure that we have a sustainable growth over time. We have the -- what we have seen is that we can take increases. And usually, the market follows us on this regard. Where we have seen some more competition is really in the fleet size. The fleet size, as you know, we almost insure 1 of every 2 trucks in Mexico, which is good, and that is because of our specialization, our coverage throughout Mexico. And yes, we have seen some increase in competition there, but we continue to provide good service, good -- very good risk control. We have very nice risk control programs we have with our customers, and that will continue to preserve Quálitas as I have seen. One of the things is that because of car theft, we have seen some -- we saw big increases in pricing in the -- in heavy equipment, in trucks over the past couple of years. And yes, we have seen some fleets that -- now it's very expensive for them to continue insuring so they are having third-party liability. But regarding, generally speaking, the pricing environment, clearly, we'll be -- we'll remain competitive, but we feel that Quálitas is well positioned to do what is needed to maintain the profitability and to maintain a healthy business going forward.

[Unknown Executive]

Is there any other question in the line, operator?

[Operator]

We have no further questions. [Operator Instructions]

[Jose Correa Etchegaray, executive]

Okay. Okay, operator, if there are no more questions, I'm glad for all of you that participated. And as you know, we are ready to help you with further questions that you may have. And as I mentioned before, I'm looking forward for you guys to be able to meet our new CFO, Bernardo, who will continue -- or who will be a great addition to our organization for Quálitas in the years to come. Thank you very much to all of you.

[Operator]

Thank you. Ladies and gentlemen, that concludes the conference call for today. You may now disconnect. Thank you for joining, and have a good day.