Australia | Oct 18 2019
Bank of Queensland has myriad issues to deal with and brokers expect revenue growth will be difficult over the next couple of years with the stock likely to underperform.
-Few positives in the FY19 results and the final dividend is reduced
-Asset quality deteriorates, impairment charges increase
-Loan growth not considered strong enough to offset margin headwinds
By Eva Brocklehurst
Bank of Queensland ((BOQ)) and its new CEO have a large task ahead to elucidate a strategy for the future that will reinvigorate confidence, amid mounting regulatory costs and pressure on interest margins. Revenue growth is expected to be difficult and the stock considered likely to underperform.
Brokers expect CEO George Frazis, who will present a market update in February, will need to focus on areas where the bank can derive an advantage, such as in Virgin Money Australia. Yet, Morgans points out, upward pressure on the cost base is very likely over the next two years given the extent of the investment required to resolve the problems.
Bank of Queensland has already flagged a potential expansion of BOQ Finance and a simplification of processes, as well as an accelerated investment in the digital roll-out of Virgin Money Australia. However, UBS warns, despite revenue growth, few in the digital banking segment have delivered strong earnings to date.
Bell Potter welcomes the "sensible" lowering of FY20 cash net profit expectations given the inevitable cost blow-out and management distractions this year. In its FY19 results Bank of Queensland announced cash earnings of $320m and reduced the final dividend to $0.31 versus $0.34 at the interim. Revenue was boosted by trading income while net interest margins eased further, to 1.92%. Credit growth was 1.6%.
There were few positives for brokers to laud. Some steps have been taken towards dealing with risk settings and capital strength, but brokers agree there is a long way to go. Morgans assesses the bank, at present, is not creating shareholder value. If the decline in the return on tangible equity is not averted then the broker may consider the stock is diminishing shareholder value.
Citi suspects earnings, the capital position and, possibly, the dividend are all set to deteriorate again in FY20 and downgrades to Sell from Neutral. The broker suggests there is little confidence in the sustainable profile of the business at this point, given the uncertainty about a resumption of growth to levels in line with peers as well as the level of returns that can be generated.
Macquarie notes the CET1 position deteriorated further in the second half, to 9.04% from 9.26%. Despite a discounted dividend reinvestment plan, the broker continues to envisage the current pay-out ratio is unsustainable.
Asset quality has deteriorated, stemming from several large commercial exposures including agriculture. This was one of the more disappointing aspects of the report, Morgans believes. Impairment charges increased by 80% versus the prior year, with $22m attributable to a rise in collective provisioning as lending growth continued in BOQ Finance. However, Citi suspects falling borrowing costs should provide relief and keep bad debts in check, for now.
Margin headwinds are likely to persist for the next three years, in Morgan Stanley's view, unless the three-year swap rate rises 40-50 basis points from current levels. Bank of Queensland is also competing hard for deposits although it appears slightly less vulnerable than peers, the broker assesses, to a squeeze on low-cost deposits from further official rate cuts.
Loan growth is not considered strong enough to offset the margin headwinds and the broker expects fee income growth will be flat. Guidance implies around 6% growth in costs in FY20 and Morgan Stanley suspects Bank of Queensland will find it difficult to adapt to change versus its peers because of a much smaller cost base.
Furthermore, the broker expects the retail bank will be under pressure as the mortgage book has shown no growth for the past 18 months. While the bank is seeking to address loan approval times, Morgan Stanley suspects the shrinking owner-manager branch numbers and under-investment in digital will take longer to resolve.
Virgin Money Australia
While the bank is diversifying its options by investing $30m in developing the Virgin Money Australia brand into a full digital bank, the launch is expected at the end of FY20 at the earliest.
Moreover, Ord Minnett is becoming more convinced that the acquisitions of BOQ Specialist and Virgin Money Australia have introduced complexity, distracting from the core retail bank, of which the owner-manager branch network decline is symptomatic. Bank of Queensland closed five branches during the second half after closing 11 in the first half and has reduced its branch footprint to 167.
The broker suggests the bank remains too complex for the size of its footprint and is suffering from a lack of past investment in core IT infrastructure and digital capability.
UBS is not anticipating a rapid turnaround, suspecting the stabilisation of the retail mortgage book is likely to be challenging, as it has already shrunk -16% from its peak in the first half of FY16. The broker expects net profit to fall a further -11% in FY20.
FNArena's database has two Hold ratings and five Sell. The consensus target is $8.49, signalling -8.4% downside to the last share price. The dividend yield on FY20 and FY21 forecasts is 6.3% and 5.9% respectively. Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, has a Hold rating and $9.10 target.
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