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Bank Of Queensland Yield Still Impressive

Australia | Oct 07 2016

This story features BANK OF QUEENSLAND LIMITED, and other companies. For more info SHARE ANALYSIS: BOQ

Bank of Queensland's results failed to impress brokers given margin pressure and subdued volumes, but the outlook has not deteriorated.

-Mortgage volumes expected to recover with reductions in discounting by peers
-Yet mortgage re-pricing could still be offset by ongoing competition and impact from lower rates
-Underlying cost growth guidance of 1% may be ambitious
-Strong dividend yield underpins stock and limits downside


By Eva Brocklehurst

Bank of Queensland ((BOQ)) produced a soft FY16 result, with cash earnings of $360m being lower than generally expected. Margin pressure and subdued volumes were the main reason the results failed to impress brokers.

With improved conditions recently experienced in mortgage and deposit pricing, Ord Minnett observes the weak margin did not reflect these new dynamics. While the margin re-basing in the second half is significant, with a seven basis points decline to 1.90%, the outlook is now considered clearer.

Rules regarding the net stable funding ratio (NSFR) have been clarified and this eases the pressure on the bank to gather deposits, and when combined with lower front-book discounts on mortgages, should, in the broker's view, provide for significantly fewer margin headwinds in FY17.

Meanwhile, mortgage volumes are expected to recover with a reduction in front-book discounting by peers, and the ongoing growth in Bank of Queensland's specialist book as well as the new Virgin-branded product. Hence, Ord Minnett believes the bank is well positioned to return to growth in FY17.

The broker regards the stock as fair value and, while finding better value elsewhere under coverage, rates it a Hold along with National Australia Bank ((NAB)) and Westpac ((WBC)).

Macquarie believes the stock may look relatively inexpensive, particularly versus Bendigo & Adelaide ((BEN)), but there is better value to be had in the major banks. The key disappointment was the net interest margin, partly, as the broker observes, because of the bank's desire to strengthen its funding mix ahead of regulatory changes.

Macquarie suspects the benefits of mortgage re-pricing are likely to be offset by ongoing competition and the impact of lower interest rates. In isolation, the revenue trends suggest the earnings backdrop is challenging in FY17 and the broker is pleased the bank is cognisant of the need to manage costs.

That said, underlying cost guidance for growth of just 1% is considered ambitious, particularly in the light of the expected rise in amortisation expense and cost growth from the Virgin product. Macquarie calculates the bank will need to achieve a 5% reduction in expenses from productivity benefits to achieve its guidance.

While struggling to reconcile the extent of the underperformance on interest margins in the second half, Goldman Sachs concludes that the pressure should subside. In its view, the bank should be able to partly offset the pressure from a flat outlook for non-interest income via cost reductions, and there is nothing to suggest a material deterioration in asset quality is likely in the near term.

Goldman no longer forecasts earnings-per-share growth into FY17 but suspects share price downside could be limited, given the strong dividend yield and a relatively undemanding FY17 price/earnings ratio of 12.2x. Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Neutral rating with a $11.59 target.

Citi does not believe the soft revenue outcome in FY17 is the whole story, with second half revenue growth of 1% actually slightly ahead of other banks which have recently reported. The broker believes, instead, that Bank of Queensland was caught up in a late cycle investment in its mortgage distribution capability, launching these products into an ultra-competitive market.

The broker also accepts net interest margin pressures should ease as, with very little recent front book growth, more of the recent back book re-pricing will hit the bottom line. Moreover, despite the missteps in FY16, the challenges faced in FY17 are not unique to Bank of Queensland. Citi notes the bank remains differentiated from its peers by its strong capital position and high dividend yield.

Credit Suisse downgrades its estimates by 8-10% following the result. The broker liked the cost discipline emerging and improved asset quality metrics but did not like the soft margins and contraction in the mortgage portfolio. The broker suspects the key risks are to the downside in terms of net interest margins and an adverse turn in the credit cycle.

Mortgage re-pricing failing to offset funding costs and asset competition highlights the fragility of the bank's funding profile, which Deutsche Bank attributes to an inability to raise deposits without offering interest rates that are much higher than peers. While the ability to improve deposits will take time the broker believes, with uncertain margins and asset growth, the stock's valuation is fair and deserving of a Hold rating.

FNArena's database has two Buy and five Hold ratings for Bank of Queensland. The consensus target is $11.64, suggesting 5.4% upside to the last share price. This compares with $12.00 ahead of the results. Targets range from $10.50 (UBS, yet to update on the results) to $13.75 (Citi). The dividend yield on FY17 and FY18 is 7.0% and 7.1% respectively.

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