Bank of Queensland: Beautiful One Day

Australia | Apr 18 2024


Bank of Queensland’s result beat forecasts but brokers claim low quality, and line up to retain Sell ratings.

-Bank of Queensland H1 beats on earnings
-Brokers point to low quality
-Management’s targets set to be lowered
-Digital transformation offers execution risk

By Greg Peel

Brokers assume the market must have held rather underwhelming expectations for Bank of Queensland’s ((BOQ)) first half earnings result released yesterday given the surprisingly positive response in share price (+5.2%).

It is true that cash earnings, which were down -33% year on year, came out better-than-expected but it is agreed the 'beat' was of low quality, driven partly by lower bad debts, temporary margin tailwinds and slower expensing of investment spend.

The 17c dividend was either in line with or better than brokers had estimated.

Net interest income (NII) contributes around 91% of Bank of Queensland’s revenue compared to 78- 85% for the major banks, Morgans notes. NII, which was down -6% on the prior half, was in line with expectations, albeit with a higher net interest margin (NIM) than the majors, down -3 basis points to 155bps, and lower interest earning assets, down -2% half-on-half, than forecast.

Return on equity fell -40 basis point to 5.8%.

Management expects "margin pressure to moderate in the second half", but Morgan Stanley believes the better-than-expected margin was largely due to lower liquidity. While the outlook commentary provides some reassurance that a three-year period of significant margin decline has come to an end, this broker does not expect much of a revenue recovery over the next twelve months.

Going Digital

Brokers agree the regional lender's digital transformation program is a positive long-term strategy, aiming to deliver a lower cost, but remain wary of both the high degree of execution risk and the potential for going over budget on investment spend, as has often been the case historically when banks undergo such large-scale initiatives.

The structural headwinds for the bank are still fairly obvious in UBS’ view, notably around NIM declining, operational expense rising, and the ability to effectively price and compete (grow) in a higher interest rate, commoditised, competitive landscape. The key question for UBS is where to from here on regulatory risks and strategy delivery.

Brokers agree management’s FY26 targets of a cost to income ratio of 50% and better than 9.25% return on equity are likely to be lowered.

The bank’s targets are premised on a reversal of cyclical factors including margin compression, Goldman Sachs notes, which if structural, would present additional challenges to an already challenging target.

Citi agrees FY24 is likely to be the bottom for the current earnings contraction cycle. Therefore, looking forward, it will be the medium-term outlook that will drive the share price, and this is where uncertainty for investors has increased.

Management conceded there is no discernible path to the FY26 targets. With these targets likely to be relinquished in the second half, this creates uncertainty around future returns for a bank with a too-high cost of funds trying to compete in very competitive asset markets, Citi warns.

Management appears to be accepting the difficulty in achieving FY26 targets, Macquarie agrees. While this shouldn't surprise the market, given the structurally challenging operating environment for a small player with a weak deposit franchise, this broker continues to see a large risk to consensus numbers in FY25-26, particularly if rates stay higher for longer.

Management now concedes reaching the targets requires margin expansion, which may no longer be on the cards, says Jarden. Hence, management is considering other options such as a "bolder simplification" cost-out program, which the broker expects to hear more about at the full-year results.

Bad Debt Risk

While the loan-loss charge was low, leading asset quality indicators deteriorated, JPMorgan notes, with 90-day arrears rising across all portfolios and new impaired assets up half-on-half. At this stage, the deterioration is largely as the broker would expect, but this should contribute to normalisation of loan losses in coming periods.

Capital was broadly in line with JPMorgan’s expectation, but while the CET1 ratio was at the top end of the guidance range, there is no capital surplus and low profitability will necessitate Bank of Queensland capping its growth ambitions, in this broker’s view.

The first half result lacked positive catalysts, says Macquarie, which about sums things up.

No Love

Last week Ord Minnett, whitelabeling Morningstar research, suggested Australian banks will raise margins via changes to loan and deposit pricing to counteract low credit growth, softer net interest margins, and an increase in short-term loan losses over FY24.

Bank of Queensland is the broker’s preferred regional bank and attracts an Accumulate rating.

Ord Minnett (Morningstar) is looking very lonely, but has not yet updated on yesterday’s result.

All of the other five brokers monitored daily by FNArena have a Sell or equivalent rating on the stock. Goldman Sachs and JPMorgan also have Sell, while Jarden is 'brave' enough to retain a Neutral rating.

The consensus target among the six daily-monitored brokers is $5.66, suggesting over -7% downside. However, take out Ord Minnett’s $8.00, which may yet be revised, and consensus is $5.19.

Goldman Sachs has a $5.44 target, JPMorgan has $5.00 and Jarden has lifted its target to $5.80 from $5.70.

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