EUR 850.00 For Business Accounts Only

Morningstar | No Major Surprises Expected When Suncorp Reports FY18 Results. FVE AUD 13 Unchanged

No-moat-rated diversified financial services firm, Suncorp Group, reports fiscal 2018 results Aug. 9 and we expect a steady, but uninspiring performance. We downgraded fiscal 2018 forecast in February following a disappointing first half impacted by surging insurance claims and greater-than-expected investment in the business. Our fiscal 2018 cash profit forecast of AUD 1.07 billion implies a fall of 7%, modestly higher than consensus estimates, not an inspiring result. CEO Michael Cameron needs to start delivering on promises, unfortunately for shareholders, but the big uplift in earnings is guided for fiscal 2019. Our fiscal 2019 cash NPAT forecast of AUD 1.15 billion is about 12% below consensus estimates.

Our AUD 13 fair value estimate is unchanged, and at current prices, the stock is overvalued, trading 15% above our valuation. We prefer competitor Insurance Australia Group due to stronger earnings growth forecasts and a lower premium/valuation of 10%. Stark differences in operational performance of Australia's two largest general insurers was evident in first-half results and we expect the same for the second half. Our fiscal 2018 dividend forecast of AUD 73 cents per share represents an unsustainably high 88% payout, well above the 60%-80% payout range. The payout should steadily decline to 78% by end fiscal 2022. The fully franked final dividend is expected to be AUD 40 cents per share in line with the fiscal 2017 final dividend.

Despite our cautious view, Suncorp's stock price has increased a healthy 13% since mid-February as the market gains confidence in management's ambitious earnings growth targets. We think the market has got ahead of itself and we remain unconvinced Suncorp can deliver on its fiscal 2019 guidance for a significant uplift in performance. If achieved, the business improvement program will be a great outcome for shareholders, but we remain sceptical, with major disruption to business momentum likely.

In fiscal 2019, the business improvement program is guided to drive annualised operating expenses back to AUD 2.7 billion from at least AUD 2.8 billion expected in fiscal 2018. The underlying insurance margin is guided to be at least 12% in fiscal 2019 and in the bank, the cost/income ratio target is approximately 50% and the net interest margin in the 1.80%-1.90% range. For first-half fiscal 2018, the bank cost/income ratio was 54.9% and the net interest margin was 1.86%.

Despite our concerns, management argue good progress is being made with the execution of the business improvement and marketplace acceleration strategies. We do not share their confidence and remain sceptical meaningful improvement in profitability will be delivered within the two-year guided time frame. Fiscal 2018 guidance is for the business improvement program to deliver net benefits of AUD 10 million pretax. Net pretax benefits of AUD 195 million and AUD 329 million are guided for in fiscal 2019 and fiscal 2020, respectively.

Group cash return on equity, or ROE, is guided to 10% in fiscal 2019 and excess capital is to be returned to shareholders. We forecast a ROE of 7.8% for fiscal 2018 improving to 8.3% for fiscal 2019 and around 10% for fiscal 2021. We can see progress, but not to the same extent as management. Despite guidance, we forecast an underlying insurance margin of 10% in fiscal 2019 increasing to 12% in fiscal 2021. We do like the commitment to return surplus capital to shareholders and the high dividend payout.

A consistent concern is the insurer's track record in underestimating natural hazard claims costs as occurred in the first half with Australian natural peril costs of AUD 395 million exceeding the allowance by AUD 65 million. Despite the business shortcomings, the balance sheet remains strong with AUD 381 million in capital surplus to operating targets.

Despite our cautious view, we forecast healthy EPS growth from fiscal 2019 onwards. We forecast average EPS growth of about 10% to end fiscal 2022. Over time, we expect improvements in underlying profitability and dividend to boost shareholder returns. By fiscal 2022, we forecast the insurance margin and ROE to gradually improve to 13% and 11%, respectively.