Marcia Dents Suncorp But Dividend Intact

This story features SUNCORP GROUP LIMITED. For more info SHARE ANALYSIS: SUN

-10% return on equity unlikely
-Special dividend still probable
-Should hazard allowance be raised?
 

By Eva Brocklehurst

Cyclone Marcia battered the Queensland coast last month, dampening expectations insurers would get through this season relatively unscathed. Suncorp ((SUN)), being the largest insurer in the Sunshine State, has advised on the likely claims impact. The company now considers its 10% return-on-equity target for FY15 is unlikely to be achieved.

Approximately 10,000 claims are in train from Marcia, the majority relating to damaged homes. Suncorp’s costs are around $120-150m net of reinsurance recoveries. As a result, catastrophe claims are now trending above budget. Following Brisbane’s hail storm claims in the first half and now Marcia, Suncorp has disclosed its natural hazard expenses for FY15 to date are in the range of $690-720m. This is in excess of the FY15 allowance of $595m.

Even without another major event, Deutsche Bank expects the remaining four months of the financial year will push Suncorp above its second half budget. As a result the broker downgrades FY15 earnings forecasts by 3.2%. The broker is not surprised the 10% return target has been ditched. Even before Marcia the broker assumed a normal catastrophe budget in the second half would make for a 9.7% return in FY15.

The above-budget costs will dent the surplus and, although a special dividend is still highly likely, Deutsche Bank reduces the amount allowance. The potential for a meaningful FY16 special dividend now appears more reliant on Suncorp convincing the regulator and rating agencies of the merits of its diversification benefit, in the broker’s opinion. Macquarie, too, does not expect material changes to the dividend without another significant event and forecasts a 20c special dividend payment at the August result.

UBS considers over-runs in natural peril allowances as largely cosmetic but a more conservative tack on allowances may be an initiative for the incoming CEO and the impact will, the broker assumes, have implications for underlying margins. In JP Morgan’s view, the 10% ROE target was always in doubt. The broker has a bearish stance on the stock, with a weak general insurance outlook on the back of the cycle pressures affecting commercial insurance, and unsustainably high margins in personal lines based on significant market share losses in home and motor. The broker acknowledges this is offset somewhat by the prospect of capital management initiatives.

Hazards were always going to be a risk to targets, in Citi’s opinion. This will be the ninth year out of ten that the insurer has exceeded its hazard allowance, which suggests that the allowance is inadequate and also implies the true underlying insurance margin may be lower than current disclosures. Citi now forecasts a return on equity of around 9.2%.

Outstanding reinsurance issues in relation to 2011 also cloud the outlook, as these are still subject to legal debate and the cost to Suncorp appears unlikely to be zero, although Citi acknowledges it will be probably lower than the maximum $118m net tax. If this case is not settled completely in Suncorp’s favour then the excess above allowances will rise. The broker suspects there is some risk from exceeding allowances relating to the make up of the final dividend but has made not changes to estimates, moving forecasts instead to reflect a pay-out ratio of 84%, above the 80% desired maximum.

With a slowing top line and transition to a new CEO, Citi envisages the risks around the stock are rising. Citi also doubts whether Suncorp can tolerate more hits to its margin before the final dividend is threatened. A possible offset is the possibility that reserve releases will be higher in the second half. There is a strong dividend yield which should remain a source of support for the stock in this low interest rate environment. That said, the broker considers the stock fair value and retains a Neutral call.

There are no Buy ratings for Suncorp on FNArena’s database. Rather, there are five Hold and three Sell. The consensus target is $13.90, suggesting 1.9% upside to the last share price. targets range from $13.00 to $14.69. The dividend yield on FY15 and FY16 forecasts is 7.35 and 6.5% respectively.
 

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