Is Suncorp Kidding Itself?

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This story features SUNCORP GROUP LIMITED.
For more info SHARE ANALYSIS: SUN
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

-Bullish targets maintained
-Capital returns feature
-More competitive product offer
 

By Eva Brocklehurst

Suncorp ((SUN)) has showcased the perennial problem of managing bank margins while maintaining growth. With benefits from more favourable funding costs and lower deposit spreads, the net interest margin in Suncorp's banking division improved to the top end of the company's 1.75-1.85% target range in the first quarter and management expects this will be sustained in the near term. Credit quality was strong and gross impaired loans were down 16%. However, the total loan book contracted 0.9% in the quarter and growth was sub-system in all segments.

Suncorp expects overall loan growth to resume in the second quarter and has reaffirmed bank division guidance, with the cost-to-income ratio now expected to be nearer 50%. UBS expects Suncorp is headed for a solid first half and, along with Credit Suisse, surmises that no update on the general or life insurance front must be a positive (given updates in recent years have been invariably negative). Nevertheless, UBS highlights the bullishness that is reflected in the company's growth targets, and this is one of the factors behind the broker's Sell rating. Credit Suisse believes, with general insurance earnings coming under pressure, Suncorp will require bank and life division growth to fill the earnings gap.

The first quarter fell short of the company's growth ambitions and UBS wonders whether Suncorp can really deliver both growth and margin targets. Deutsche Bank, too, considers the company has sacrificed growth for margins in the first quarter and questions whether top line growth of 4-6% will be achieved. The mortgage market backdrop remains competitive but as management is more attuned to expanding margins, this suggests some upside risk to short-term earnings if similar attention is paid to the larger general insurance division. Deutsche Bank gives Suncorp the benefit of the doubt and retains a Hold rating.

Asset quality within the bank is improving and the company has confirmed shareholders should expect further capital returns, but the share price has had an exceptionally strong run and Bell Potter now believes a Hold rating, downgraded from Buy, is more appropriate. The broker considers the revised rating still adequately reflects the company's "cash" status and capital returns should feature in the medium term. Bell Potter also presumes, should underlying trends and benign weather patterns prevail, Suncorp has the capacity to sustain a yearly 15c special dividend over the next 2-3 years.

Citi believes a return to growth in the second quarter is a reasonable expectation and that Suncorp will reach its return on equity target of 10% in FY15. This will need a major improvement in bank profit but higher net interest margin, lower impairments and lower cost-to-income ratio should help. The reason the broker is confident regarding a return to growth is that there is a now more competitive product on offer with lower risk, while higher quality lending is also in the mix. The product offer was only released at the end of September so the contribution to growth should appear in the second quarter, and there were signs in October that its reception was strong. The first tranche of the banking platform replacement should be live at the end of November and Citi expects, should all go to plan, the banking cost-to-income ratio will be on track for the 53% FY15 target.

JP Morgan envisages profit will remain strong in the near term but at some point the growth issue will need to be confronted. The broker acknowledges pressures on lending in the September quarter primarily stemmed from a sharp reduction in the proportion of very high loan-to-value ratio loans, which the bank indicated was an effort to improve the risk mix and get ready for the eventual adoption of advanced accreditation. Nonetheless, the broker expects in the longer term, growth will necessitate margin contraction while a weak general insurance outlook may weigh on investor sentiment in the short term. The main upside for the stock is likely to come from capital returns and cost reductions. At best, Suncorp is an FY16 story for JP Morgan.

On FNArena's database Suncorp has one Add rating, five Hold and two Sell. The consensus target is $13.98, suggesting 6.8% downside to the last share price. The dividend yield on FY15 forecasts is 6.4% and 6.0% on FY16 forecasts.
 

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