Suncorp Negotiates The Bend On A Bumpy Road

This story features SUNCORP GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: SUN

-More special dividends expected
-Gross written premium slows
-Growth target a challenge
-Margin gains may be sacrificed

By Eva Brocklehurst

Suncorp Group ((SUN)) is at a crossroads. The finance and insurance company has negotiated some potholes in FY13 and simplified its business but the road taken may still throw up plenty of challenges.

The FY13 results delivered few surprises, given the company pre-released the thrust of the report some weeks back. Highlights included the extent of the capital surplus, a core bank net interest margin above the target range and a further small improvement in the underlying general insurance margin. Of some concern was the gross written premium (GWP), which slowed to 5.5% in Australia in the second half, down from 9.3% in the first half. For Credit Suisse, this highlights the pressure the company is under with its growth target of 7-9% for FY14.

Citi also thinks the growth target will be a challenge although has erred in the company's favour on this one, noting Suncorp appears confident it can pull the right levers to achieve it. Credit Suisse concedes the underlying insurance margin improvement in the second half, to 13.6% from 13.4% in the first half, was an impressive result in the context of a drag of more than 1% from lower investment income. The broker also believes the current general insurance margins can be maintained in the near term but believes GWP growth is likely to slow significantly. Citi was less convinced on the impressive nature of the second half margin improvement but expects Suncorp will become more aggressive on the margin versus growth trade-off, albeit gains will be relatively modest. The broker notes the result was delivered without significant reserve releases. Releases were $4m below the longer-term target.

Cost growth outpaced revenue growth, leading to a modest deterioration in the cost-to-income ratio. This was a negative for Credit Suisse. The company also mentioned an ongoing preference for fee-free banking and increased loan commissions being paid on the back of volume growth. Also not positive. Additionally, there were mark-to-market losses on financial instruments within non-interest income. Credit Suisse did like the non-housing balance sheet momentum and market share gains in the agricultural business. Net interest margin expansion was applauded, with underlying net interest spreads expanding. Impairments as a percentage of gross loans were stable over the second half. Nonetheless, overall, there was not enough in the story to change Credit Suisse's Underperform recommendation.

Citi was more upbeat and the stock remains the broker's top pick in the insurance sector. More special dividends are likely and the potential was welcomed by Citi and Macquarie. Suncorp had $847m of total capital in excess of operating targets at 30 June, after allowing for payment of dividends. With diversification benefits potentially being added this year, Citi has lifted the FY14 special dividend forecast to 20c. Macquarie factors in a 15c special to second half FY14 forecasts.

The banking division is in a transition year in FY14 and Citi thinks it should look better by FY15. The life business was again impacted by experience losses and the lapse assumption change could lower planned margins by around 25% in FY14, according to the company. Further to this, with no change to the claims assumption, the claims experiences losses are likely to continue. Citi is reticent about giving Suncorp too much benefit of the doubt in life insurance, but still allows for superannuation to improve and does not expect a recurrence of the $6m process change costs. Suncorp may have challenges but should still deliver reasonable profit growth, and then there's that potential special dividend pay-out. Accordingly, with the uncertainties surrounding the FY13 result alleviated, a strong capital position maintained and reasonable valuation Citi has returning to a Buy call.

While the capital surplus should support further returns and underpin the stock's yield appeal, Deutsche Bank thinks the growth and return on equity story is less convincing. General insurance growth targets are ambitious and the broker suspects it may require sacrifice of recent margin gains. Core bank returns are slipping and life insurance continues to deliver returns well below the cost of capital. All up, a very mixed outlook in Deutsche Bank's opinion. The yield may be attractive on a 12-month view but the broker thinks forecast compound annual earnings growth rates of 4.6%, while solid, are not spectacular. Hence, Deutsche Bank finds greater value upside in QBE Insurance ((QBE)) and that's its top pick among Australian general insurers.

Suncorp's consensus target price is $12.94 on the FNArena database, suggesting 2.9% upside to the last share price. The dividend yield is 6.4% on consensus FY14 and FY15 earnings forecasts. There are four Buy ratings, three Hold and one Sell.
 

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