Suncorp Homes In On Improved Returns

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Suncorp Group remains intent on improving returns yet will have its challenges in the face of the cost increases that have stemmed from the pandemic

-Upside dependent upon achieving new targets
-Moving closer to returning excess capital
-Reserve releases likely to remain ahead of normalised levels
 

By Eva Brocklehurst

Insurance volume growth and high bank interest margins drove strong headline results for Suncorp Group ((SUN)) in the first half. Volatility was heightened, hence the trajectory is not straightforward as benefits ensuing during the pandemic will ultimately drop out.

Expenses are a headwind going into the second half and this means much of the growth will come from the benefit of premium rate increases and claims efficiencies. Nevertheless, Suncorp is seeking to automate its core business and drive returns above the cost of equity through the cycle.

Morgans assesses the business has come through the downturn created by the pandemic relatively well and there is upside to be had as the insurance book is re-priced and the economic environment improves.

Macquarie agrees re-pricing will be key to maintaining underlying margins as cost increases will create new headwinds. This also assumes hazards, investments and reinsurance impacts are consistent half on half.

Suncorp produced 4.0% growth in gross written premium in the half and the mix of business appears relatively stable. Motor insurance volume grew by 5.3% and home by 5.1%, with the former featuring improved vehicle sales and more targeted marketing.

Margin

UBS believes the upside is now dependent on the company signalling how it will achieve its new insurance margin and return on equity (ROE) target. At this stage, the broker does not expect the low end of the 10-12% margin target by FY23 will be achieved, given the low interest-rate environment.

The company may have more information up its sleeve but in normalising and assessing real margins, UBS finds there has been no improvement during the first half. As a result, if these targets are achieved, and with the stock trading on a -30% PE discount to the market, the broker considers a Buy rating appropriate.

The margin target in the insurance business appears realistic at the lower end, in Morgan Stanley's view, despite low yields and rising catastrophe budgets. The broker expects insurance margins can recover to 8.5% in the second half and agrees a further recovery will have to wait until FY23.

Morgan Stanley assesses Suncorp's underwriting is not as streamlined as peers but this should improve, and anticipates flat mortgages in the second half then 4% growth in FY22.

In the bank, UBS forecasts margins will fall -3 basis points in the second half after expanding by 8 basis points in the first half on the back of the switching to low-cost transaction accounts from term deposits and amid subdued mortgage growth.

Suncorp has increased its total business interruption provisions to $214m to reflect additional potential for exposures relating to prevention of access. UBS believes this is likely to be sufficient while Macquarie is wary of ongoing court cases.

Capital Return?

Morgan Stanley believes Suncorp is moving closer to returning excess capital and is positioning for sustainable top-line growth throughout both the insurance and banking segments. Nevertheless, it is likely to be FY22 or FY23 before the benefits emerge. The company's plans involve some upfront investment in FY21 in order to deliver lower costs by FY23.

While Suncorp appears unwilling to commit to a capital return as uncertainties over the pandemic linger, Citi suspects by August concerns could dissipate and, with a strong surplus capital position, a return may be on the cards alongside the FY21 results, slated for the first quarter of FY22.

Suncorp has pointed out it rarely considers capital returns in the first half of a fiscal year and wants to monitor at least one quarter without the fiscal support measures such as JobKeeper.

Regardless, the increase in costs is likely to depress near-term returns and Citi concludes it is too early to be fully confident in the medium-term outlook. Recent rate increases in the Australian home and commercial insurance portfolios are yet to flow through to the underlying margin and there is likely to be around $80m in costs to absorb in the second half.

Reserves have been topped up because of business interruption provisions and reserve releases are likely to remain ahead of normalised levels. Suncorp has benefitted from ongoing releases from green slip (CTP) and workers compensation insurance where its portfolio is skewed towards the resources sector.

Citi forecasts second half reserve releases, in stark contrast to Insurance Australia Group ((IAG)) which has guided to nil reserve releases in FY21.

FNArena's database has four Buy ratings, two Hold. The consensus target is $12.04, signalling 12.2% upside to the last share price. The dividend yield on FY21 and FY22 forecasts is 5.0% and 5.1%, respectively.

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