Cost Savings Critical to Suncorp’s Earnings

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

-Seen defending market share, margin
-Increased investment in digital platform
-Reserve releases remain elevated
-Few details on life division
 

By Eva Brocklehurst

What a difference a month or two makes. After Cyclone Marcia earlier this year, Suncorp ((SUN)) feared it would fall short of its 10% return-on-equity (ROE) target and brokers hastily downgraded forecasts. Now the company suggests it can achieve ROE over 10% in FY16 and there is potential for this target to be closer to 12% over a three to four year period.

Suncorp has announced new cost saving initiatives which are expected to deliver $170m in benefits by FY18. This is in addition to the simplification benefits previously announced and ongoing. A large amount of the simplification savings came from general insurance and this is again expected to be the case, while personal insurance expects $100m of benefits by FY18 by redefining the claims value chain. Commercial insurance lines are also benefitting from a strategy to combine CTP (green slip) and workers compensation into a single managed class.

Most analysts came away from the investor briefing with increased confidence the company can deliver the goods, albeit wary about translating too much benefit to the bottom line. Deutsche Bank believes Suncorp is well able to manage the growth/margin trade off that is necessary and the efficiency savings should enhance strategic flexibility as the insurance cycle slows. This should allow the company to reinvest in areas where it needs to maintain market share. Despite upgrading medium-term forecasts, Deutsche Bank envisages upside risk to a 9.75% ROE forecast. Combined with a FY16 forecast yield of 7.6%, this supports the broker's Buy rating.

At this point, Citi expects the efficiency benefits will support, rather than add to, estimates. The broker is cautious about the renewed call for "sustainable" ROE of over 10%, noting the company is now increasing its investment in more capital intensive businesses and its cost of capital is now around 9.0%. The broker believes most of the savings will be reinvested in order to protect margins. Embracing an advanced digital function in business intelligence, to deliver better analytics, could provide a competitive advantage, Citi acknowledges, and progress so far is encouraging.

The savings are unlikely to show up on the bottom line but the efficiencies should enable the insurer to maintain market share and a solid profit margin in general insurance, in Credit Suisse's view. The business that will deliver real savings in coming years – banking – is actually excluded from this savings target, the broker observes.Suncorp's banking business is on track for a lowering of the cost-to-income ratio to below 50% by FY17. 

Credit Suisse believes Suncorp is better positioned than either Insurance Australia Group ((IAG)) or QBE Insurance ((QBE)) in terms of holding onto its margins. As around 35% of the company's earnings are outside of general insurance there are also growth opportunities. Positive industry dynamics are resulting in a slowing in premium rates. Home premium rates continue to slow while motor premium rates are under the most pressure, so Suncorp's ability to pull out costs is critical to holding market share and margins.

Macquarie suspects Suncorp is using premium rates to defend market share in general insurance, while targeting lower costs in order to maintain margins. The broker does not expect material changes to the outlook in the absence of another major catastrophe. Morgan Stanley is of the same opinion. The broker still believes the group 10% ROE goal is a stretch but the upgrade to the banking platform could drive margin upside.

The risks for Morgan Stanley lie with the transition to a new CEO in October and the underlying margin outlook. The broker retains an Underweight rating, observing the benefit of cost reductions is hard to isolate from the likely increase in the FY16 catastrophe budget. Suncorp has exceeded its catastrophe budget in eight out of nine years and this implies underlying margins closer to 9.0%, while a desire to protect market share also reduces the emphasis on top line growth targets.

Two other drivers of general insurance are reserve releases and natural peril claims. Management has indicated the level of reserve releases are likely to remain elevated. There is little doubt that Suncorp needs to increase its natural peril allowance but, in isolation, Credit Suisse observes the company has actually significantly increased this in recent years. Its allowance now rests above that of IAG. While acknowledging a lack of deep understanding of reinsurance, a period of slowing earnings growth and after almost a decade of natural peril disappointment, Credit Suisse believes investors could benefit from increased reinsurance protection.

One aspect of the briefing which disappointed Credit Suisse was the Life business. There were hints but few details on growth opportunities in retirement income. The broker suspects, given recent disappointments, the company is keen not to over-promise on the Life business. Still, Credit Suisse is encouraged by commentary that the Life business is performing in in with the re-set base assumptions, although notes that the lapse rate assumes further deterioration in coming years.

FNArena's database shows two Buy, four Hold and two Sell ratings for Suncorp. The consensus target is $13.74, suggesting 2.4% upside to the last share price. Targets range from $13.00 (UBS) to $14.60 (Macquarie). The dividend yield on FY15 and FY16 consensus estimates is 6.6%.
 

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