BOQ Selling Overdone?

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– BOQ tops up provisions, warns on profit
– Five ratings downgrades follow
– Bad debts remain an issue
– Long term picture still positive

By Greg Peel

After management issued a profit warning on Friday, Bank of Queensland ((BOQ)) shares fell over 5%. They're down 4% again today mid-afternoon. The warning comes ahead of the bank's FY12 upcoming earnings result.

It wasn't so much about BOQ's second half profit guidance per se, which at $220-225m is roughly in line with consensus. The issue is with a $15m top-up to provisions for bad and doubtful debts (BDD). The market believed BOQ's first half review of its loan book and $160m provision increase, followed by a substantially dilutive capital raising, signalled the end of the BDD issue. The amount itself is not so ominous, and analysts concede it is likely a one-off, but just when the market was becoming more comfortable with BOQ (which had rallied around 17% since mid-July), more BDD problems prove disappointing.

The provision “top-up” follows “ongoing challenges that exist in the broader economy and property market,” management explained, “particularly in South East Queensland”. BA-Merrill Lynch suspects the problems are at the “smaller end,” and RBS Australia is happy to believe the top-up is a one-off given the bank's portfolio review is now over 80% complete. Deutsche Bank believes the $15m is indicative of increased provisioning for existing impaired assets rather than a sign of further deterioration in the ratio of non-performing loans – a view supported by Macquarie.

Analysts may be playing down the BDD issue, but it hasn't stopped them reconsidering their recommendations. All of Merrills, Credit Suisse, RBS and Deutsche have now downgraded their ratings for BOQ to Hold from Buy (or equivalent), while UBS has hung on to its previous Hold rating.

Merrills had thought BOQ had troughed now that the raising had been digested, provisioning had been assumed to be sound and a new strategy had been put in place. But Merrills now fears the BDD top-up may suggest a further “drip feed” of problems, especially given the deteriorating macro backdrop in Australia. The analysts find BOQ's upside case no longer attractive relative to the ongoing risks.

Credit Suisse finds the top-up disappointing, coming so soon after the first half provision increase, and bemoans the end of what had up to now been positive newsflow. There's no longer scope for an upside surprise at the official result release, CS assumes.

For RBS the real issue is not the provisioning but the fact revenue growth now looks much weaker than the analysts had expected. While fresh reported profit guidance was roughly in line, underlying profit guidance falls short of forecasts. BOQ's balance sheet looks much safer post-raising and the bank's provisioning levels and capital ratios are sector-leading, but the second half update to revenue and margins suggests BOQ has struggled to find top line momentum, the analysts believe.

Deutsche Bank analysts are prepared to take the provision top-up as a one-off but are concerned that recent signs of economic weakness may drive a higher level of impairments in FY13-14. Deutsche has adjusted its forecasts accordingly.

UBS suggests the top-up has undermined the market's conviction of provision adequacy, and believes stability in asset quality will have to be exhibited in the first half of FY13 if the stock is to sustain a re-rating.

Brokers have noted that the $70-75m in BDDs expected in the second half is 20% higher than consensus, which was sitting at $60m. While this may have been the consensus figure, it appears to be very much the average of a wide range of BDD forecasts. UBS seems rather caught out on a forecast of $35m, while Goldman Sachs overshot at $85m. It just goes to show that predicting BDDs is no stroll in the park. On a $50m range among brokers, $15m seems less material.

While Citi was sitting on a forecast of $78m, the analysts have downgraded BOQ to Sell from Neutral despite maintaining their price target. BOQ is trading at 0.9x book value, they note, and delivering well below cost of capital on the forecast horizon.

Conversely, JP Morgan has upgraded to Neutral from Underweight. The JPM analysts had watched the BOQ share price rally strongly and suspected the market was underestimating the potential for further impairments. Now that another $15m has been thrown at those impairments, the risk/reward trade-off is more evenly balanced, JPM suggests.

The above is a good example of why less experienced stock market investors must appreciate the difference between absolute earnings performance and the gap between that figure and what the market forecasts that figure to be. Stock prices do not wait for earnings results and guidance upgrades before they move up or down, rather ongoing forecast manipulation determines today's price. Consensus forecasts are reflected in the share price, but the individual views which define consensus can vary greatly. That's why some brokers have had to upgrade their BDD assumptions for BOQ post-warning and others downgrade, and why resultant earnings forecast downgrades range from 60% (on a small figure) to 2%. RBS has also downgraded its dividend forecasts by 2%.

Then there's the matter of how one looks at the bigger picture, or greater horizon.

Goldman Sachs has retained its Buy rating, noting management's suggestion that, despite the top-up, the bank's arrears trend has actually improved in recent months. Goldmans also notes a recovery in Gold Coast-Brisbane property prices according to the RP Data-Rismark measure. The analysts still believe long term upside is evident for BOQ given the bank is well placed for a Queensland recovery, its portfolio is being further de-risked, and cost restructuring is yet to provide benefits.

Macquarie (Outperform) could not agree more. The analysts calculate the $15m top-up was worth four cents per share, yet yesterday the market fell 40cps (and is down another 30cps today). BOQ's bad debt provision coverage is now 89%, the analysts note, which puts it in the middle of the Big Four pack and well ahead of fellow Queenslander Suncorp ((SUN)). “The BOQ story is not about balance sheet and provisioning,” rails Macquarie, “It's about the turnaround”. The analysts see provisions declining in FY13.

Macquarie upgraded BOQ straight to Outperform from Underperform last month.

There is little doubt, however, the gloss has come off Bank of Queensland. As a new government tries hard to turn the state around, nationally the economy appears to be sinking into the mire. Further provisioning, no matter how inconsequential, only serves to stoke nervousness with regard to SEQ bad loans. BOQ shares have now taken an even bigger hit post five ratings downgrades (and one upgrade) and are seen as good value by at least a couple of brokers. It will take a while, and some more encouraging news from BOQ in FY13, for confidence to improve.

One for the longer term investor.

After all the ratings changes, The FNArena database now shows one Buy, six Holds and one Sell on BOQ. The consensus target has fallen to $7.68 from $8.05 in a range from Citi at $7.15 to RBS at $8.28. Consensus suggests upside of 6% at the current price, plus dividends.
 

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