How High The Special Dividend For Suncorp Shareholders?

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 – Suncorp's investor day highlights cost saving potential
 – Underlying margin guidance better than had been expected
 – Brokers speculate about the potential for the upcoming special dividend(s)
 – Buy ratings dominate on valuation grounds

By Chris Shaw

Suncorp Group's ((SUN)) investor day yesterday showed management is attempting to control what can be controlled through simplification, an approach UBS suggests is appropriate in the current low growth and risk averse environment.

One element of the business that can be controlled to some extent is costs, and here Suncorp is looking to make significant progress in coming years. Simplification benefits could amount to as much as $200 million by FY16, notes UBS, on implementation costs of around $275 million.

While the savings are a positive Credit Suisse notes detail has to date been scant, particularly with respect to how much overlap there is between the Simplification and Building Blocks programs in place.

The other issue noted by JP Morgan is while the initiatives seem sensible, management are yet to decide whether savings achieved will be given to shareholders in the form of profits or reinvested in the business to drive growth in later years. 

Assuming the savings are returned to shareholders by way of higher earnings, Deutsche Bank estimates there could be a boost of 10% to net profit after tax by FY16. This full benefit appears unlikely as Deutsche expects some of the savings will be reinvested in growth.

From an earnings perspective, the investor day highlighted management now expects to achieve underlying margins of 12% for FY12. This comes just a few months after management attempted to hose down such an expectation, though UBS for one is somewhat cynical given it comes just two weeks after Suncorp announced $714 million of escalating natural perils claims.

Assuming the underlying margin of 12% can be achieved it bodes well for FY13 as well, Deutsche Bank noting a higher run rate and incremental Building Block program benefits can deliver margins for next year of 12.5%. This compares to the broker's previous forecast of 12.0%.

On the back of the update to margin guidance, brokers across the market have made minor changes to earnings estimates. UBS has lifted its earnings per share (EPS) forecasts by 1c each in both FY12 and FY13, while Goldman Sachs has changed its forecasts by 1% in both years. Consensus EPS forecasts for Suncorp according to the FNArena database now stand at 64.4c in FY12 and 81.7c in FY13.

The market remains positive on capital management potential from Suncorp, JP Morgan noting the company at present has around $1.2 billion in surplus capital. Short-term a special dividend is seen as most likely, J Morgan expecting a 10c special at the upcoming result and Citi factoring in a 25c special.

With only minor changes to earnings estimates post the update there has been only one change to broker ratings. That was by Macquarie, who upgrades to a Neutral recommendation given recent share price weakness means the current price better reflects the balance of risks in relation to under provisioning in the non-core bank business.

All other brokers in the database continue to rate Suncorp as a Buy, as does Goldman Sachs.

Morgan Stanley is not in the FNArena database but rates Suncorp as Equal-weight within an In-Line view on the sector. The reasons for the rating are there remain some question marks with respect to margin quality, falling yields, higher reinsurance in FY13 and recurring non-core bank provision top-ups. As well, Morgan Stanley suggests the amount of capital available for distribution by Suncorp is uncertain at present, which offers some scope for disappointment relative to market expectations.

The Buy argument is primarily a valuation call and reflects both the potential for earnings to improve as Suncorp delivers on efficiency programs and the positives of likely capital management initiatives in coming years.

On Deutsche's numbers Suncorp's core business is trading on a FY13 multiple of just 7.6 times, which implies compelling upside from current levels. Credit Suisse agrees, in part given the expectation of $200 million of special dividends in each half of next year. This would boost the yield on Suncorp to 11% for FY13.

Suncorp's upside potential is reflected in the consensus price target as calculated by  FNArena with the target of $9.28 suggesting upside of around 19% relative to the current share price. Price targets range from Macquarie at $8.62 to JP Morgan at $10.40.

Shares in Suncorp today are weaker in a lower overall market and as at 11.05am the stock was down 5c at $7.76. This compare to a trading range over the past year of $6.03 to $8.85. 

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