Porto Seguro SA

BOVESPA:PSSA3

Earnings Call Transcript 2019-Q2

[Operator]

[Interpreted] Good morning, ladies and gentlemen. At this time, we would like to welcome everyone to Porto Seguro Second Quarter '19 Results Conference Call. Today, we have with us, Mr. Roberto Santos, the company's CEO; Marcelo Picanço, Vice President of Insurance, Investments and Investor Relations; Celso Damadi, Controller and Vice President of Finance and Support; and Lucas Arruda, Head of Strategy and Investor Relations. We would like to inform you that this event is being recorded and simultaneously translated. [Operator Instructions]

We have a simultaneous webcast that may be accessed through Porto Seguro's website at www.portoseguro.com.br/ir. At this address, you will find the banner conference call, and this is where you will find the presentation platform. Questions can also be made via the webcast clicking on the platform at the speaker icon. The team will be arranging the order of questions to ensure a comprehensive section.

Before proceeding, we would like to mention that forward-looking statements made during this conference call are based on the beliefs and assumptions of Porto Seguro's management and on information currently available for the company. They involve risks, uncertainties and assumptions as they relate to future events and, therefore, depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Porto Seguro, and cause results to differ materially from those expressed in such forward-looking statements.

We would now like to turn the call over to the company. You may proceed.

[Roberto de Souza Santos, executive]

[Interpreted] Good morning to all of you. This is Roberto Santos, and I would like to thank you for participating in the earnings conference call for the second quarter '19. In the second quarter, our profitability growth dropped mainly by the increase in the financial and service business results and by the expansion of financial assets. In insurance, there was a drop in the premiums due to the technical adjustments in prices for auto insurance carried out in 2018 due to the drop in theft and robbery. On the other hand, although the economy of this country has not grown very much, we increased our fleet to 200,000 vehicles vis-à-vis 2018. We would like to highlight a growth of 10% in Life and Health insurance and 24% in the financial risk portfolio.

In terms of operating results, we have a rate -- combined rate of 93.4%, remaining 2.5 percentage points below the average of the last 5 years. In terms of loss ratio, there was an improvement because of a drop of loss ratios, were also in more than 4 point -- percentage points. The rate for this quarter is below the historical average and within levels that we deem to be appropriate, considering our strategic and profitability goals.

Administrative and operating expenses and insurance also had good results remaining stable in the first half of the year, explained by the expansion of our efforts to increase operating efficiency. And we believe that our focus in optimizing core will be a relevant leverage to broaden our growth potential in financial and service businesses. We also expanded our results through a greater contribution in credit operations and the reduction of costs associated to Conecta. A new novelty this quarter was the implementation of -- nation-wide level of a new co-branding for auto insurance. This is a new model that generates operational efficiency gains and the potential of offering 3 brands. Another important piece of news during the period was the choice of Porto Seguro as the best company in the stock exchange as announced by Infomoney.

To conclude, we're very satisfied in ending the first half of 2019 with an increase in net earnings above 10% and an increase in our profitability. Our greatest challenge today is to speed up the growth of business. And for this, we are enhancing our product offering, focusing on differentiation, innovation and profitability aligned with the needs and preferences of clients. We believe that the markets that we are present in hold several opportunities that will be increased with the resumption of economic growth.

I would now like to request that Marcelo speak in more detail about our results.

[Marcelo Picanço, executive]

[Interpreted] Thank you for your presence at our conference call. I would like to go on to Slide #5 and show you the growth of our revenue and explain what underlies this. This was a quarter where we were faced with greater challenge in terms of the expansion of revenues, basically due to a technical price adjustment in the auto segment, corresponding to 73% of premiums issued. Obviously, this is below our historical growth, but I would like to highlight that this is not a problem of productivity considering that in the last 12 months, we have increased our insured fleet by 200,000 vehicles. Our challenge in the Auto business arises from what happened in 2018, where we had an increase of prices in the first semester with a drop in the loss ratio that became more intense in the second semester, leading to a reduction in premiums, differently to other sectors where we are impacted by inflation or we remain between inflation and 0. Our market states that in risk movements, we have this impact on our premiums.

On the other hand, in other types of insurance, as we mentioned, we want to have a stronger expansion, and we have a growth of 2 digits in Life insurance and Health insurance, with results that are above the Auto results. The combined insurance results, which in Brazil is relevant to compare because of the importance of the income statement for our results is very appropriate as Roberto mentioned, according to our strategic goals. The combined ratio that we had in the second quarter of 2018 and the third quarter was below 92%. These were exceptional results, the best results we had in a decade and the present-day results, which is approximately 2 points more of 93%. Once again, it is a very good result for the quarter, much better than the average of the last 5 years. Therefore, we feel comfortable with the combined ratio that we have. We have good margins when we speak about the company's products.

To speak about the consolidated results for insurance on Slide #7, we see that the results have alternated since 2018. 19% for the second quarter 2019 compared to 24% in the last quarter of 2018 compared to values that were much lower because of the market situation, margin compression and prices in 2016, 2017.

I would like to underscore, once again, that we're making a more efficient use of our capital, and we have obtained profitability that is doing very well despite the challenges that we face in growing. When we focus, specifically, on each project separately, for the results of the first semester 2019 and the second quarter 2019, we have a more robust expansion in Health and Life and a more challenging scenario in the Auto business, and due to issues -- due to an impact that we had in the entrepreneurial sector of 2%, we have taken the appropriate measures. So once again, resume growth as soon as we are able to observe that the second semester will be better than the first semester.

In the Auto, the technical review that we carried out, despite the fleet expansion, was not sufficient to offset the technical price adjustments. Despite this, the results were 3.2% lower than the last quarter. Nevertheless, we would like to highlight that the phenomenon of trends that we observed, they do not point to another reduction, which means that the continuous expansion of items should lead to better results and growth. Of course, this is not a promise nor a forecast. This is simply a trend that we have observed more recently.

In terms of Insurance, in the last decade, what we have observed is that the concerns that the market brings is the possibility that the company will be able to deliver a final or combined ratio in an environment with very low interest rates. Historically, we have obtained very low rate of interest. Historically, at present, our interest rate has been the lowest in the last 30 years, but we observed that although the amplified combined ratio has fluctuated more in the last 2 years, this only reinforces the fact that the amplified combined ratio results from the management of 2 equations, so financial and the operational one and evidently, an environment where the interest rates are low, we do adopt some measures. First of all, we have to deliver better operational performance in terms of pricing and efficiency gains as we will show you further ahead, where we have achieved significant results in the last 5 years. And we have to protect our financial portfolio, so that we can work with these lower interest rates peaking, results that are above the benchmark, and we believe that we have obtained this in the last few years.

In the long term, this long-term allocation should not be based on interest rates or posted rate for the long term. Now if we look at the historical loss ratio, especially for the Auto business, because when this grows, we need to understand where we are. Clearly, the figures show us that the loss ratio for the second quarter of 2019, mathematically, was worse than in the second quarter of 2018, but we should look at some things in perspective. The second quarter of 2018, as mentioned before, was exceptional in terms of loss ratio of 51%, 52%.

Secondly, when we look at all of the second quarters in the last 5 years -- 5 to 6 years, what we observed is that we are still at a loss ratio that is 2 percentage points below the average of the last 5 years. Additionally, we have improved the loss ratio compared to the second quarter of 2018, as we had a more intense impact in the state of São Paulo due to the rainfall, the rainfall was outside of the curve and did not fit within the forecast and the historical rainfall for the period. So we do have an enhancement in the margin of more than 4 points between one quarter and the other, and a position of the loss ratio 2 points below the average in the last 5 years, which means that we are comfortable with our present-day loss ratio. This is not a source of concern for the time being.

As was mentioned by Roberto, we have implemented changes in our new offering model for automobiles. We're working with 2 factories, 2 technical models that are Porto Seguro and Azul, and we are taking advantage of the power of working with the most valuable brand of Brazil, Itaú. We maintain the Itaú offering that can be offered based on the consumers and brokers' preferences and can be done jointly with any of the other drill factory. This is done with offers made through the bank sector and to bank holders and through any channel, and the most important channel for also being that brokers -- once again, this is available on our colocation platform and it attempts to reduce operational complexity, increase efficiency and, of course, increase our competitiveness. And the contracting processes for insurance have been simplified and it enables us to maintain a level of attractive -- attractiveness that we have always had with our clients.

I would now like to refer to efficiency gains. As a company, we are focused on differentiation and service. Nevertheless, this does not allow us not to focus permanently on efficiency and an enhancement in efficiency. And we're not only concerned in increasing margins for shareholders, what we want is to focus on growth, have a nominal growth because in the final account, this account has to be paid for by somebody. Therefore, while in the period of 2015, The crude inflation reached 21% in Brazil and our administrative and operational expenses had a drop of 2% -- plus 20, minus 2. We'd like to show you this in a longer perspective, so as to point to the coherence of our efforts that are not isolated or timely efforts in 1 year and are not repeated in the coming year. We're not going to carry out any of rough levels that will modify our service levels with customers, but it is our obligation to improve processes and have efficiency gain, not only because they bring us financial gains, more competitiveness, but because customers demand better attention as do brokers and -- for us, this is strategic, and it gives us a strategic view of efficiency.

Let us speak a bit about our financial and service business results. We had a net earnings that increased significantly, mainly due to the expansion of credit operations and because of a cost reduction related to businesses that does not have a good performance, such as Conecta. Here, we look at the total figures, with a slight reduction, and this refers to the discontinuation of the Conecta operation that was generating revenue but not results. Looking forward, we need to focus more on the revenue evolution of our main business as Credit and Consortium of 7.7% and 12%, respectively.

To speak a bit about our investment results that this quarter had a notable profitability of 158% of CDI. I would like to underscore that the growth of 46% refers to a strategic allocation here to offsetting the drop in the interest rate. This is not something that began yesterday. It has been ongoing for years and has allowed us a better historical position in post fixed. Many years ago, this was 70%, 80%; presently, it is 35%. Once you have a very low cash, you need to carry out allocations, not that are high risk. We have a historical volatility of remaining at 0.5%. This is not high, but there are 2 factors here, strategic allocation -- or 3 aspects, [ he corrects himself ], the positive wave in several assets, especially variable income, the low interest rate and the comparison basis harmed vis-à-vis the second quarter of 2018. That was a quarter with significant difficulty for these assets in Brazil, because of this, our financial revenues were hampered and we had a negative result vis-à-vis other assets, such as Pension and Insurance, referring to some securities that have greater risk such as equities and others. When the market is strongly impacted, these are the assets that are more impacted, and this is what happened in the second quarter of 2018, where our results were not good. In this quarter, we are delivering positive results, allowing us to feel more comfortable as we go forward in terms of our allocation, vis-à-vis the economic scenario, especially in the short term.

Finally, I would like to underscore what has appeared, so market comments or questions, and that refers to the effective tax rate. Here, we have some phenomenon, part of this refers to a decrease of the tax rate set forth by the government, part refers to the discontinuity of Conecta, and a very significant part refers to the mix of financial revenues that I have just mentioned. Because of a structural tax issue, we have the concentration of our greatest assets, and our tax rate is practically 0 lower than in the Insurance business when we have financial gains in the Porto Seguro S.A. company and the totality of the revenues. Our financial, the effective tax rate is the lowest in the company. Now when this company has losses, we do not obtain this gain. Last year, we had a loss in financial revenues of BRL 35 million. At the -- now this year, we had a gain of more than BRL 54 million of variable income assets with a very poor performance in the second quarter of 2018 and with very good performance in the second quarter '19.

Now this phenomenon where we generate our financial revenues impacts the average tax rate. And every time that we have had a financial results in our more risky assets, shares in multi markets, every time this has been negative, the effective tax rate increases because they are allocated to a company that pays less taxes because of its company set up. And I think this is something that has not been properly explained, and I would like to shed light on these that have arisen in the market.

We go on to Slide #16 and speak about our net earnings and ROAE. Our net income has been above 18% in the second quarter. This was somewhat more difficult and we were able to increase our total net income in -- by 14%, as you can observe. We continue to remain in a situation of profitability and with an expansion of net income when compared to the second quarter of 2018. The consolidated results, when we look at these from a more strategic viewpoint, and if we go back decade, shows the soundness of the results of the company, despite the different economic scenarios, micro economic scenarios of competition in the sector and interest rate level. And it is a fact that we do have a cycle from very poor years, some semesters that have been very poor, such as in 2011, 2016, but these are rare. Mostly we have historical results above the cost of capital and more specifically, expanding to levels that are over 20% with a certain soundness more than 20%, not only because of an expansion of net income, but also due to a more efficient capital allocation. Last year, we carried out a record payout of dividends and in so far as possible, what we tried to do is optimize our results and our payout to optimize our return on capital.

Finally, as we have always done, we show you the main figures for the semesters in the year, and we would now like to offer you the floor for questions and answers.

[Operator]

[Interpreted] [Operator Instructions] Our first question comes from Felipe Salomao from Citibank.

[Felipe Salomao, analyst]

[Interpreted] Marcelo, Roberto, Lucas, I would like to further explore the expectation the company has with the growth of earnings or revenues in the Auto business. This issue has already been mentioned during the presentation, notwithstanding this, what is it that you have in mind for the second semester? I think there has been a lot in market share when it comes to the insured fleet in the second quarter vis-à-vis the first quarter of this year. And despite this, prices continue to drop, it seems that the market is quoting below what Porto Seguro is quoting, therefore, what is it that you have in mind? Are you thinking of having a price reversion in the industry? And has there been a decrease in the loss ratio of other competitors? And are we going to be entering a new cycle of growth that will be healthier, perhaps? Once again, what is it that you're thinking in terms of the second semester regarding these issues?

[Marcelo Picanço, executive]

[Interpreted] This is Marcelo. And thank you for the questions. I'm going to try to explain it in the following way: First of all, we observed a market scenario for Auto insurance, in general, that is not very irrational. There is no price war. There is one player in general, but we do not observe this in general in the market. This is a market with very tight margins. Historically, the players work with negative results or with combined points above 100. But this is a test. Now the drop in the average premium that you have observed is minimum, not because margins have dropped, but because we have changed the situation due to the loss in risk. That is a structural factor. We have seen an increase in robbery and theft, and this year, we had a drop in robbery and theft, and as you change yours and we change every month by 112, that is why the premium drops because the total stock of the insured fleet for each company is trending towards a lower risk ratio.

Now our outlook for the second semester is more positive than in the first semester. First of all, the economic reality and the confidence of people, we think this will lead to a greater expansion, and expansion here is not only in GDP, it is also an expansion in confidence leading to more purchases, more investment and so on and so forth. The second factor is that in our vision, we will not have another technical price review. We don't have the elements that will lead us to doing this once again, and of course, this had an impact on our results last year. Thirdly, we are setting forth several initiatives that have nothing to do with price. We should not think that an increase in sales should only base itself on price increases, we're struggling with this in the last 40 years. We need to be better equipped to work with Credit Cards, for example, recently, this month, we launched an incentive campaign to purchase cars for new clients with facilitated payment conditions and discounts for the Auto customers. Within that vision of working with cross-selling and retaining the customer longer with us of decreasing that direct comparison only with price and to feel that there is more added value and greater ease. And this is what customers speak sometimes, customers not only base themselves on price, but of course, we cannot generalize this. And we're working with cross-selling, of course, trying to leverage auto sales, which is our main product. We do have a card and the card has been created to be an instrument of relationship. It is not only for credit. The question we're asking is how does a card help us in improving customer relations? So we feel very positive going forward. The adjustment has been implemented for this and our main concern is the growth of our main business, of course, but I would like to highlight, once again, that we have an increase in fleet. We have not lost in terms of the fleet, and it shows that we are very competitive. The problem is comparing with last year, and we have comparisons with 2 different risk levels.

[Roberto de Souza Santos, executive]

[Interpreted] This is Roberto Santos, and I would like to add two points to what was said by Marcelo. First of all, our co-branding strategy, where we are exploring 3 brands and 2 factories, 2 products only, as Marcelo reminded you, there is an operational efficiency factor, but also the conversion of business. The base of account holders in Itaú is quite large. And in the previous strategy, the account holder had only one possibility with the Itaú brand of single products with the Itaú brand. They will now have 2 brands. Two products with the Itaú brand, the Porto product and the co-branded Itaú product, and we have already perceived an increase in the account holder segment, and this will help us expand our Auto business. Another point that I would like to add is that we see the thinning down of our Azul-leaded project is a version of Azul, a lighter version of the traditional product, and we're using this as a combat product in the segment that are being explored by association for Auto protection. And there has been a great expansion in this product as well. So to support what was said by Marcelo, we're quite optimistic for the second semester when it comes to an expansion in the Auto business.

[Operator]

[Interpreted] [Operator Instructions] Our next question is from Eduardo Nishio from Plural Bank.

[Eduardo Nishio, analyst]

[Interpreted] My question is on efficiency. Do you still hope to increase efficiency in the coming quarters? I know that you have made great strides when it comes to cost, but I would like to know if you think that you will still have room for improvement.

[Roberto de Souza Santos, executive]

[Interpreted] This is Roberto. We do believe that we have a great deal of room to increase our efficiency. We have some initiatives underway. We have several projects that are being implemented, the review of processes, investment in technology, but mainly a review of our processes in all of the company areas. And I would like to highlight that in the company, we have begun to have a culture of efficiency that is being awarded in-house, and this is something that is here to stay. Without a doubt, therefore, we're going to move forward with this and with the growth in earnings that we expect for the second semester, we will still see a continuity in the reduction of operating and administrative expenses.

[Eduardo Nishio, analyst]

[Interpreted] And could you give me perhaps more details, more color in terms of where you can continue to cut cost? Is it in the brand integration process or investment in other units, perhaps, that are not that profitable?

[Roberto de Souza Santos, executive]

[Interpreted] Well, without a doubt, we're still going to have a great deal of advantage from the closing of a plant. We have 3 automobile plants. We can still read several good results there, but there are several opportunities. Just to give you an idea, this is part of our day-to-day work, sometimes we're in a Board meeting, and we identify the opportunity to cut down on accommodation and air ticket costs. These are not large projects only, we have just gone through a middle segment where we see a cut in expenses, not observe the expenses but there is the opportunity to cut down on cost. So managers have detected opportunities in all of the areas of the company, and this is thanks to the culture that we have disseminated in-house, something that was not so clear in the past.

[Operator]

[Interpreted] Our next question is from Guilherme from JPMorgan.

[Guilherme Grespan, analyst]

[Interpreted] I have 2 very short questions. The first referring to taxes that you commented on, I just want to make sure if I understood properly of allocating on the holdings S.A. So you pay taxes of 40% there and everything that is not a technical reserve goes into -- let's say, you pay 34%. Now the surplus capital that you have, you allocate in the S.A. company. The second company refers to noninsurance, if you could give us a rapid overview of the credit area, how is the environment and the demand for your product?

[Celso Damadi, executive]

[Interpreted] This is Celso, Guilherme. I will respond to what refers to taxes and Marcelo will speak about credit. Well, the taxes are very simple, our technical reserves have to remain in each insurance company because of regulatory issues of SUSEP. So these technical reserves remain in this area. In the first part, we have a trough of taxes because of social contribution on profit. It was 5%, but not fully 5% because of the negative impact on shareholder profits, and the average ended up being a drop of 4% approximately. Now when we have surplus capital, we carry out allocations in the holding and our controlling company, because at the holding, the tax rate is of 34%. But besides having the tax rate of 34%, we have accumulated fiscal losses and this [ JCT ], depending on the amount and the -- that we have at the holding, the effective tax rate can be 0. What happened in second quarter is that we had net earnings and the effective tax rate was 0 because we had the [ JCT ] in the second quarter, and the effective tax rate was 0. If we compare this with the second quarter of last year, we had a loss in the holding last year. When we compare the effective tax rate for both quarters, '18 and '19, the holding represents a reduction of 7% in the effective tax rate, and it comes from that capital allocation based on revenues of the holding itself.

If we have not had that reduction of tax rate, the effective tax rate in the consolidated results would have been 7% anyway because of a reduction due to the financial allocation where we had greater profitability this quarter. And based on social contribution, it was only 3% for the consolidated results in the quarter. I'm not sure if I was able to explain this. So you know, it was very clear. Therefore, based on regulation, whatever is not a technical reserve, any capital surplus is allocated at 34% effective taxes, just to optimize those capital gains, because at 34%, we have an accumulated fiscal loss, and normally, what we pay is less than 34%. And invariably, the tax rate ends up being 0.

[Marcelo Picanço, executive]

[Interpreted] Guilherme, This is Marcelo. Let me speak some more about credit and our viewpoint on this. We do think that we can have a further expansion. We have been cleaning out our portfolio. We no longer have inactive or -- cards or cards that are unused because this confirms capital. So we went through some quarters, reducing the inactive customers, so we would like to have a further expansion in credit. And of course, this expansion has to be done within our strategy. Porto customers, and those who could become Porto Customers, as I said, the credit card is a relationship tool for us, and we offer it to reinforce, to improve other relationships that are already existing or that could exist. And of course, because of this, we do look upon our default rate a great deal. If we are faced with a very restricted position, we will no longer be able to offer these products to customers that have a greater risk. Now having a greater risk doesn't mean having worse profitability. We could work well as long as we're very concerned given the offering of credit cards. We do have some customers with a higher risk, but if they pay, they are part of our customer base. Now if customers would pay us in cash, we would have lower risks. Well, so we work with customers with a moderate risk that give us greater profitability, comes up with a better score. Now if we base ourselves only on the default per portfolio and not the cost of risk, we also divide this by the revenue generated, we would have a bias, and we will try to simply minimize default. We do have an advantage as we work with customers that have lower risk compared to the customer from banks, so from the retail market, but evidently, we do not want to be excessively conservative, putting up a barrier in the expansion of this business.

Roberto, I would like to go back to the question that was asked before, that refers to efficiency. We have an installed capacity at present to take on a much larger volume of business and doubtlessly, this is also important, and it will translate into greater operating efficiency with a reduction in operating expenses.

[Operator]

[Interpreted] [Operator Instructions] As there are no more questions, we will return the floor to the company, for their closing remarks.

[Roberto de Souza Santos, executive]

[Interpreted] I would like to, once again, thank all of you for your questions, your contributions and interest in our company. Should you have additional doubts, please do not hesitate in contacting our Investor Relations areas, or visit our IR area, www.portoseguro.com.br/ir. Thank you very much.

[Operator]

[Interpreted] Thank you. The conference call for Porto Seguro ends here. We would like to thank all of you for your participation. Have a nice day.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]