Australia | Oct 13 2017
The main positive that brokers glean from Bank of Queensland's FY17 results is the improved capital position and they speculate how the bank may divvy up the funds.
-Potential for further special dividends and/or investment in digital
-Stock now considered expensive, reliant on mortgage re-pricing by majors to justify premium
-End of mortgage bull market and competition limit the upside
By Eva Brocklehurst
Bank of Queensland ((BOQ)) has warmed to the benefits of mortgage re-pricing and better funding conditions but brokers now believe the stock's re-rating has captured this scenario. The main positive from the FY17 results was the bank's capital position. This will jump 20-25 basis points with changes to accounting for securitisation and general reserve credit losses in January.
The finalisation of APRA's "unquestionably strong" capital requirements has enabled the bank to undertake capital management initiatives to improve shareholder returns. UBS calculates this should place the bank's CET1 ratio at around 9.6%.
Bank of Queensland has indicated it could utilise some of this capital for digital transformation, but the broker envisages such an investment as stay-in-business operating expenditure. Hence, UBS increases operating expenses forecasts by $25m from the second half.
The broker also believes Bank of Queensland is unlikely, in a slowing credit growth environment, to organically deploy capital, instead suspecting a preference for further special dividends. As a result, UBS factors in the removal of the DRP discount and factors in two more special dividends of 8c per share in the second half of both FY18 and FY19.
Morgans takes another view, suspecting a further return of capital may not eventuate as the company has indicated a preference for digital transformation. The mention of accelerating the digital transformation highlights a need for the bank to further improve mortgage fulfilment times and improve customer satisfaction, the broker suggests.
There may be scope for a further special dividend, given the strength of the capital position, and assuming the bank discounts the DRP from the second half, in Credit Suisse's view. However, this is not factored into estimates. The broker suggests the first preference appears to be deploying capital into loan growth, followed by franchise investments, accelerating digital transformation and restructuring, rather than capital management.
Balancing out the fundamentals with valuation Credit Suisse retains a Neutral rating. Should the bank continue to re-rate further in the near-term the broker would consider a less positive valuation-based view on the stock.
UBS remains cautious about extrapolating the strong result in FY17 as Bank of Queensland's results tend to swing around more than other banks. Following the rally, the stock is now trading at a PE ratio of 14x, in the broker's opinion the most expensive bank in Australia.
UBS believes Bank of Queensland is relying on further mortgage re-pricing by the majors to justify its premium, and this appears less likely in the current environment. Nevertheless, the broker acknowledges the prospect of further special dividends may attract yield-hungry investors.
Macquarie agrees slowing credit conditions and headwinds to mortgage profitability in the longer term do not bode well and considers Bank of Queensland fully valued at current levels, maintaining an Underperform rating.
The broker suggests the bank's elevated mortgage spreads, coupled with shrinking owner-manager footprints and inferior systems, continue to affect its ability to grow. Housing volume growth remains well below system despite an increased share of broker flow. Moreover, Macquarie expects housing credit growth to slow in FY18/19 and put further pressure on the growth profile.
Citi downgrades to Neutral from Buy, believing while the bank is relatively well-positioned against a challenging industry backdrop, it has outperformed for investors this year and no longer offers much upside. The broker notes, going forward, costs will rise as investment in digital capabilities becomes a priority. The broker expects revenue growth to hit a wall after the re-pricing initiatives wear off during the first half.
The bank reported FY17 cash earnings of $378m, up 5%. A fully franked final dividend of 38c was declared along with a special dividend of 8c, representing a pay-out ratio of 84%. Ord Minnett observes Bank of Queensland's housing credit growth has slowed considerably after its out-of-cycle rate rise, which coincided with higher discounting from the major banks.
Credit growth in housing did turned positive in the second half and the broker is confident the bank can build on this performance, yet net interest income remains vulnerable, with a number of the bank's peers lowering account fees and few opportunities for trading operations.
Bank of Queensland has benefited from a sweet spot in margins, as well as an improved franchise performance and sound credit quality but Morgan Stanley believes, with trading multiples at multi-year highs, earnings momentum will slow. The broker downgrades to Underweight from Equal-weight, while acknowledging volumes via brokers and branches has improved and the niche growth options provide a source for differentiation.
This has allowed mortgage growth to turn around after a negative first half. While the results show evidence that management has lowered its risk profile in recent years, the broker believes loan losses will increase in FY18, to around 17 basis points of loans. If this does not occur, Morgan Stanley's earnings forecasts would be around 5% higher.
FNArena's database shows five Hold ratings and three Sell. The consensus target is $12.09, signalling -6.6% downside to the last share price. The dividend yield on FY18 and FY19 forecasts is 6.1% and 6.0% respectively.
This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
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