Market Overpricing Bank Of Queensland

This story features BANK OF QUEENSLAND LIMITED. For more info SHARE ANALYSIS: BOQ

-Challenges despite turnaround
-Key positive is improved asset quality
-But ambitious targets factored in
-Margin could still be under pressure
 

By Eva Brocklehurst

Bank of Queensland ((BOQ)) has pulled up its socks. After a comprehensive review and re-capitalisation the bank is moving on to the next challenges. Significant opportunities exist, especially as Queensland's economy recovers. Nevertheless, the market is becoming increasingly competitive and the share price rally in the wake of the FY13 results appears to have jumped the gun, encouraging several brokers to downgrade recommendations and most urging caution.

On the FNArena database there are six Hold ratings and two Sell. The consensus target price of $10.48, which is signalling 6.3% downside to the last share price, has risen from $9.88 ahead of the results. The dividend yield on FY14 consensus earnings forecasts is 5.4% and on FY15 it rises to 6.0%.

During the last six months the bank has made a material improvement in asset quality, with a 20% reduction in impaired loans. UBS believes there are significant opportunities in agricultural and business banking but considers the bank has under achieved its potential in retail banking. The story may be one of a classic turnaround and the broker is impressed with the speed at which the bank has cleaned up its impaired assets but, given the share price has rallied 28% since June and the stock is now on a 13.1 times price earnings ratio, the broker has downgraded the rating to Neutral from Buy.

The balance sheet growth prospects are more constrained than those of peers, in terms of both capital and funding, in CIMB's view. This broker also believes that, after such a rally, the bank is fairly valued on an absolute basis, despite appearing cheap relative to the big four. The main surprises for CIMB were the strength in the net interest margin, at 1.72%, the increase in the final dividend to 30c, and the cash pay-out ratio of 73%.

BA-Merrill Lynch remarks that the market may have liked the increased dividend, which was 1c ahead of the broker's forecasts, and the six basis point increase in margin, but the key driver of the better result appeared to be the re-pricing of the higher-end term deposit book and lower hedging costs. If the margin is sustainable it will give the bank flexibility going forward and help achieve the bank's stated target of 13% or more return on equity by 2015. Merrills maintains this target is still a challenge but is already factored into the share price.

The broker also thinks it unlikely that risk weightings on mortgages will be lowered for regional banks any time soon. This is where the upside potential for the stock lies in FY14/15. Merrills retains a Neutral rating and concedes a little more optimism given that, despite its history, the bank has managed a broad-based improvement. The robust risk management framework that was implemented following comprehensive reviews last year appears to be having a beneficial impact.

Cash profit was helped by stronger margins but offset by weaker fee growth. FY13 cash profit at $251m was below Macquarie's forecasts. The broker notes fee income declined 3% half on half as weakness in banking was not overcome by strength in insurance income. Moreover, a large driver of the improvement in the impairment expense came from the release of $12.8m in collective provisioning. The margin pleased the broker, benefitting from funding cost improvements and re-pricing of assets. Nonetheless, this margin could come under pressure in FY14 without benefits from the cash rate, buy-backs and/or hedging. The bank's strategy will come under scrutiny in the year ahead as Macquarie does not think success is guaranteed. Targets for improving asset growth, maintaining margins and reducing impairments were mostly met but the broker notes with interest that, while guidance for FY15 was given, no management targets were provided for FY14. It all adds up to a downgrade for Macquarie – to Underperform from Neutral.

The market may have welcomed the increased dividend but, in Citi's opinion, it further reduces the capacity for the bank to grow organically without raising more capital, albeit minimising a build-up of franking credits. The broker is concerned that the step up in middle market business lending, particularly in agribusiness, means no transparency about risk quality for several years. Citi is also mindful that loan growth was largely offset by the accelerating run-down in impaired assets and line-of-credit lending. Mortgage growth was disappointing, and there is no indication a new broker offering is gaining traction.

The broker believes there's still along way to go on the efficiency scale. Returns on equity may have lifted but are still below an estimated 11% cost of capital. Accordingly, Citi is not inclined to pay more than book value for the stock yet recognises the demand for a fully franked dividend. The broker positions the target price ($9.75) at around a 200 basis points forward yield differential to the 10-year bond rate, or an 80 basis point premium to the major bank average. A negative total return is still expected over the next 12 months hence Citi's Sell recommendation is retained.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms