Australia | Nov 26 2019
Bank of Queensland may have announced a capital raising to shore up its balance sheet and provide the flexibility to improve operations but brokers are not that impressed.
-Difficult to assess merits of capital raising without detail on transformation strategy
-Bank of Queensland will cut its final 2019 dividend by -20%
-Brokers believe a lower pay-out ratio is required
By Eva Brocklehurst
Bank of Queensland ((BOQ)) has its work cut out to impress brokers, having launched a capital raising to fund a transformation strategy which will not be revealed in detail until February. This makes it difficult to assess the merits of the new approach and the likelihood of success. The new CEO will update the market on the transformation plan is in February 2020 after a productivity review.
Moreover, it appears to brokers that revenue is not growing and expenses are rising. Bank of Queensland is flagging lower FY20 cash earnings amid rising costs. The bank has recognised the challenges from slow loan origination processes, shrinking owner manager branch numbers and underinvestment in IT.
Bank of Queensland will raise $250m from a placement at $7.69-7.78 a share, raising capital at its lowest share price in six years. A further $25m will be raised through a retail share purchase plan. The objective is to improve business operations, which involves greater expenditure on IT and reduced personnel. This is expected to reduce the time taken to perform tasks and lower the cost of tasks.
However, Shaw and Partners, not one of the seven stockbrokers monitored daily on the FNArena database, asserts there has never really been an efficiency program which enabled total operating costs to decline after execution. The broker asserts that the reason why the details of any planned efficiencies have not been provided is because, at this stage, they don't exist, and retains a Sell rating and $7.50 target.
UBS upgrades to Neutral from Sell, encouraged by the capital strengthening and the likely strategic direction, although acknowledges execution risk is high. The broker expects Bank of Queensland will focus on niche areas where it has advantage, in particular the expansion of Virgin Money Australia, but does not expect a rapid turnaround.
Priorities for the bank are to return to profitable and sustainable growth by simplifying processes, closing the digital/data gap and improving branch home loan origination. Central to aspirations is an $30m plan to build a digital bank under the Virgin Money Australia brand.
Jefferies believes this focus raises execution risk and near-term costs, as well as consumes capital. FY21 is considered a long way off, the risk/reward uncertain and the broker, not one of the seven, reiterates an Underperform rating with a $7.50 target.
Ord Minnett also argues that the focus on Virgin Money operations may be distracting from core problems, while Morgan Stanley suspects that the launch of the digital brand will occur at the end of FY20 at the earliest.
Capital & Dividend
The capital raising positions the bank to meet an increased CET1 ratio target. Bell Potter calculates, post the capital raising and after absorbing costs, the CET1 ratio would be at the top end of the 9.00-9.5% target.
Simultaneously the bank is cutting its dividend by -20%, the third reduction in 12 months. Morgans had been flagging further acceleration in investment expenditure and the risk that "kitchen sinking" by the new CEO will undermine the capital ratio. The broker expects another reduction to the half-year dividend in the first half of FY20, particularly as the bank is no longer planning to offer a price discount for the dividend reinvestment plan.
Macquarie does not believe the bank is profitable enough to support a dividend pay-out ratio above 80% and suspects it will need to further cut the "bloated" dividend in FY20. The broker now forecasts a -25% cut vs FY19. While the -10-11% discount to the last traded price appears attractive, Macquarie flags numerous regulatory and operating risks.
Ord Minnett assumes Bank of Queensland cuts its dividend in the first half of FY20 to $0.25 from $0.31, adopting the mid point of its 70-80% target pay-out range. This is higher than the broker considers sustainable for a bank with a return on equity of around 7%, although franking credits are likely to be prioritised for shareholders.
In the medium term, Morgan Stanley calculates a 50% pay-out ratio is more sustainable and should allow neutralisation of the dividend reinvestment plan, although this will be subject to the outcomes of the transformation plan.
Ord Minnett also suspects the market will be more willing to give credit for cost savings rather than revenue programs as the bank is grappling with significant structural challenges for which there are no easy fixes.
That said, the broker assesses Bank of Queensland has more of a revenue problem than a cost problem, stemming from the decline in its primary distribution network and its below-peer deposit-gathering ability as well as a poor digital offering.
Macquarie expects expenses growth will remain elevated. There are also contingent liabilities, with possible compliance contraventions of the anti-money laundering and counter-terrorism financing legislation still to be considered.
However, Morgans does not believe the latter is a significant factor behind this capital raising. Nevertheless, until the issues are resolved, revenue growth is likely to remain challenged and the stock is likley to underperform.
FNArena's database has two Hold ratings and five Sell. The consensus target is $7.79, suggesting -3.6% downside to the last share price. This compares with $8.30 ahead of the announcement. The dividend yield on FY20 and FY21 forecasts is 6.1%.
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