Australia | Dec 15 2015
-New CEO likely to take more conservative stance
-Question of which issues are unique to SUN
-Long-term margin target considered a stretch
By Eva Brocklehurst
Suspicions that FY16 might turn out to be challenging for Suncorp have been acknowledged, with the company downgrading its underlying insurance margin to 10% for the first half, after realising 14.7% in FY15.
The reduction in margin comes through rising claims inflation and a lower Australian dollar but the company has retained a commitment to “meet or beat 12% through the cycle”.
Suncorp did not detail the extent of the factors that were impacting earnings and, Credit Suisse notes, also hesitated to put a timeline on any recovery in the margin. The main drivers appear to be claims related concerns in home, motor, compulsory third party (CTP) and commercial lines.
Citi suspects the downgrade was partly because a new CEO typically re-sets expectations lower, and it remains to be seen just how much of this particular re-set is a one-off occurrence, or uniquely Suncorp's problem.
Most brokers remain cautious about the outlook, as evidenced by six Hold ratings on FNArena's database, with one Buy (Macquarie) and one Sell (Morgan Stanley). The consensus target is $12.71, which suggests 10.9% upside to the last share price. This compares with $13.72 ahead of the announcement. The dividend yield on FY16 and FY17 forecasts is 6.6% and 7.0% respectively.
There remains a case to be cautious about general insurance earnings, overall, Credit Suisse contends, with commercial premium rates continuing to decline and personal lines also coming off a year of premium rate reductions. The broker suspects Suncorp is catching up on industry issues surrounding CTP (green slips) and claims inflation.
Credit Suisse does not believe a 10% margin is the new norm but neither does it believe exceeding 12% is highly probable. Earnings estimates are lowered as is the forecast pay-out ratio, while the broker removes a special dividend – previously 12c – from FY16 forecasts.
Morgan Stanley reduces its pay-out ratio forecast to 65% but retains a 10c special dividend estimate for FY16, for now. The broker considers the 12%-or-more margin expectations are “aspirational”, observing industry feedback does not reconcile with Suncorp's performance in CTP, which puts the sustainability of super-normal reserve releases at risk.
Over-reliance on reserve releases to drive reported margin upside and support the dividend requires a price/earnings discount, the broker maintains. Morgan Stanley highlights other risks, including further falls in the Australian dollar, a normal summer catastrophe season accentuating home inflation, and losing volumes on personal insurance.
All up, the broker suspects the franchise risks are elevated. Peers that do not face similar inflationary pressure are likely to win more volume. Also, as the company nears the end of its efficiency drive, Morgan Stanley questions whether a lowest-cost manufacturer, price-led, multi-brand growth strategy is obtaining the necessary results. Optimising a vertically integrated model demands higher volumes and the broker retains an Underperform rating.
Macquarie is less worked up about the downgrade, although acknowledges the industry environment is very competitive, expecting some pricing and claims initiatives may moderate the impact on margins in the second half. The broker notes all industry participants are expecting flat or modest premium growth and commercial insurances rates remain negative.
Also, while claims on the home front have a unique frequency when it comes to Suncorp, the size of these claims reflects those of most peers. Suncorp appears to be suffering from a greater currency impact, Macquarie observes, compared with its competitors, and large commercial losses have impacted its book more so than for peers. The broker sticks with an Outperform rating.
A significant margin reduction was always highly likely, in JP Morgan's view, with the new CEO expected to take a more conservative stance. The broker had previously flagged significant differences in Suncorp's CTP classes, noting its more optimistic assumptions at a time when the industry was signalling a worsening trend. Still, the extent of the downgrade is a surprise, and the trends in Suncorp's motor and home segments appear to JP Morgan to be worse than the broader industry.
Premium rate increases are expected to come through and offset the inflation trends and this should be positive for the margin outlook. At the current price the stock offers the most upside among the broker's coverage of general insurers, but the difficulty is in establishing the underpinnings of the margin downgrades and whether these are likely to continue.
The downgrade is appropriate, rather than conservative, in Deutsche Bank's view, and restoring the margin to 12% appears a stretch in the current environment. The broker reduces its long-term underlying margin forecast to 11% and, with few positive catalysts ahead, retains a Hold rating.
UBS, too, remains cautious and suspects a further recalibrating of targets, capital strategy and growth appetite is likely from the new CEO over the next six months. With a lack of clarity around the second half, the broker is reluctant to factor in margins approaching the 12% target.
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