Suncorp’s Glow Fades As FY16 Challenges Mount

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

-Margins under pressure in GI
-Bank and life division support
-New CEO's approach in focus

By Eva Brocklehurst

Suncorp Group ((SUN)) produced a healthy FY15 result but the glow is fading as brokers envisage challenges will mount in FY16.

In an environment of falling yields, and claims inflation via a weak Australian dollar, as well as a rising catastrophe budget, Morgan Stanley flags the risk the market is over-estimating the medium-term capital benefits from internal risk-based capital models.

The broker also believes the company's reliance on CTP (green slips) for growth and underlying margin support masks the dilution of margins and value in the core personal lines franchise. On the positive side, there remains capacity for further special dividends, although the broker contends these will be lower in future. Morgan Stanley now expects a 10c special dividend in FY16.

Reserves releases underpinned the result, Credit Suisse notes, as well as higher-than-expected earnings on investment income. The broker downgrades to Neutral from Outperform, expecting core margins will decline by up to 200 basis points in FY16. Volatility in natural peril claims is declining but remains above that of its competitors.

Share price performance may have been justified in recent months because of upside risk to earnings from bank and life divisions, as well as the reserve releases, but Credit Suisse finds the next leg up for the share price is difficult to discern. 

Suncorp is now a more predictable entity and UBS hails the absence of any significant surprises in the result. Banking has modest tailwinds moving into FY16 while the broker considers life profits are supported by conservative assumptions.

Still, while the company's view that competition is easing and interest rates are potentially heading higher is encouraging, UBS notes this is not consistent with recent commentary from other industry participants. A Sell rating is maintained.

The bank and life growth should partially offset pressures on general insurance margins, in JP Morgan's view. The broker awaits further clarity on the approach the incoming CEO will take. Citi also flags its suspicion that FY15 may prove typical of a last hurrah from a departing CEO but concedes the general insurance business is coping reasonably well with the difficult market conditions.

Moreover, there are some tailwinds emerging for the banking business with advanced accreditation, a more level playing field with the major banks and a more modern banking system soon to be finalised. The broker also expects, near term, Suncorp could reap some benefit from its recent price rise on investor loans.

Citi allows for strengthened assumptions, which should mean underlying life profits improve in FY16, if FY15 lapse and claims experience are repeated. Events appear to be tracking better than Suncorp expected so far. Nevertheless, with a new CEO about to take over, and underlying margins potentially slipping, the broker believes the risks of holding the stock are increasing and retains a Neutral rating.

While the FY15 result was solid, Morgans was disappointed with the special dividend of 12c. Still, the broker accepts this leaves the new CEO, Michael Cameron, with a solid capital position. The broker remains positive on the turnaround that has been executed over the past few years but believes any re-rating depends on proving up the growth story in life and banking.

Macquarie is also Neutral on the stock, although Suncorp remains its preferred domestic general insurance exposure. The broker notes the company has used premium rates to defend the loss of unit market share in general insurance and is continuing to target lower costs to maintain peak margins in a soft premium rate environment.

There are no Buy ratings on FNArena's database but six Hold and two Sell. The consensus target is $14.08, signalling 2.1% downside to the last share price. This compares with $13.74 ahead of the report. The dividend yield on both FY16 and FY17 forecasts is 6.2%.
 

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