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Banks’ Best Turnaround Prospect: Bank Of Queensland

Australia | Apr 21 2021

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

Bank of Queensland is expected to exceed guidance and looks well positioned to deal with industry headwinds

-All three housing lending channels posted positive growth
-Strong pre-provision profit growth of 3% half-on-half
-Reduced impairments forecast
-Earnings upgrades

By Mark Story

Broadly in line with guidance, Bank of Queensland ((BOQ)) managed to deliver an improved first half 2021 result, underpinned by improving economic conditions deposit margin benefits and low impairment charges. While there were few surprises within the heavily pre-guided result, a key positive for this set of results is the housing credit growth in the bank's Blue Brand for the first time since first-half 2016.

The bank reported a first-half FY21 cash net profit of $165m at the midpoint of the guidance range, and an interim dividend of 17c also in line with guidance, with a common equity tier-one (CET1) ratio of 10.0%.

It also delivered strong pre-provision profit growth of 3% half-on-half with support from funding cost tailwinds. However, the result was achieved with very little contribution from stronger lending growth as average loans were flat over the period.

While the first half result delivered few real surprises, it confirmed that for the first time in over five years, all three housing lending channels printed positive growth, delivering overall housing growth of 1.6x system growth. Australian Prudential Regulation Authority (APRA) stats showing improvement towards the back end of the half, and significant funding cost tailwinds  which drove 3 basis points of net interest margin (NIM) expansion half-on-half to 1.95%.

Guidance appears conservative

While brokers were not expecting any surprises, with all items in line or close to forecast, some were quick to revise their forecasts based on what they believe to be potential upside yet to be factored into their numbers. As a case in point, Macquarie believes Bank of Queensland’s elevated deposit pricing should provide a buffer to ongoing mortgage margin pressures as the bank accelerates its growth agenda.

With Bank of Queensland looking less exposed than peers, Macquarie has also adjusted impairment forecasts, and currently expects benign loss rates of around 6-11bps in FY21-23.

While management continued to target ongoing market share gains, Macquarie believes its implied guidance appears conservative. Flat margins and cost growth of 3% suggest to the broker the bank is targeting revenue growth of 4%.

But assuming non-interest income is broadly flat year-on-year, this guidance implies volume growth of -2% in second half 2021, which Macquarie sees as unlikely. As a result, the broker is currently forecasting revenue growth of around 5% in FY21.

While Macquarie remains restricted on Bank of Queensland, the broker reiterates preference for the regionals ahead of the majors. But having adjusted earnings for improved volumes trends and reduced impairments forecast following improved economic outcomes, Macquarie has changed its earnings per share (EPS) forecasts by 2.9%, 4.4%, and 9.8% in FY21, FY22, and FY23 respectively.

With very little of potential upside factored into its forecasts, Ord Minnett is also estimating 5% revenue growth in FY21 versus 4% implied by guidance. The broker believes Bank of Queensland is the best turnaround prospect of the stocks under its coverage.

Ord Minnett believes this stems from addressing historical weak points such as higher deposit costs than peers, inferior customer-facing digital offering, and clumsy origination processes.

Given that near term funding cost savings from the RBA's Term Funding Facility and deposits costs, and potential for optimisation in both its own deposit book and the funding mix of ME Bank, Ord Minnett believes the bank is well positioned to deal with industry headwinds. The broker also notes bank improvements in broker channel performance and the digital offering to customers.

Meantime, Credit Suisse believes the launch of the Virgin Money digital bank provides a strong platform for Bank of Queensland to increase its efficiency as it transitions its current brands – BOQ and, in future periods ME Bank – onto a single cloud based platform.

The broker maintains an Outperform rating, and following an upgrade to earnings forecasts of 1-2% through the forecast period to reflect higher NIM (partially offset by higher expenses) has increased the target price to $10.00 from $9.50.

Unrealised potential

The as yet unrealised potential Ord Minnett is referring to includes: Improvements in deposit mix, with reduced term deposit (TD) reliance and more transaction accounts, and the delivery of revenue synergies at ME Bank. The Bank of Queensland sees potential to improve the ME Bank NIM, potentially by as much as 20bp.

Then there’s an improved offering to customers with its digital roll-out and to brokers by cementing faster approval times.

Ord Minnett’s net profit estimates have increased 3% in FY21, 10% in FY22 and 2% in FY23, with a 0–2% increase in pre-provision profit and lower bad and doubtful debts (BDD). As a result, the broker’s recommendation on Bank of Queensland has been upgraded to Accumulate from Hold, with the target price increasing to $9.50 from $9.30.

Overall, Citi also expects improved performance and asset quality to continue to drive earnings upgrades. The broker retains a Neutral call, but unlike Ord Minnett thinks much of the absolute upside is priced in.

The bank is trading on a 12.5x FY23E price-to-earnings (P/E) multiple, a 17% discount to both the major banks and its regional peer Bendigo and Adelaide Bank ((BEN)). As a result, Ord Minnett doesn’t believe the market is paying for cost benefits from ME Bank. Albeit the broker acknowledges, this will require careful execution, given the already-full transformation/fix agenda.

But despite providing scale benefits and geographic diversification, Morgan Stanley isn’t convinced that the acquisition of ME Bank materially improves growth prospects. While the transaction isn’t yet factored into Morgan Stanley’s model, the broker’s revised proforma estimates imply earnings accretion of 4% to 7% in FY23, and FY24 – with meaningful upside if management achieves its above-system growth targets.

But given the supportive operating environment, improving franchise momentum, and excess provisions and capital, potential accretion from the ME Bank acquisition and attractive trading multiples, the broker has upgraded the bank to Overweight. Morgan Stanley has upgraded FY21 and FY22 cash EPS estimates by 2-3%, and increased its target price to $10.00 from $9.60.

Market underestimating momentum

Given that the recent weak share price performance appears at odds with Bank of Queensland’s underlying business momentum, Citi suspects the market is underestimating the underlying improvement in the bank’s enhanced momentum and profitability.

While the broker believes the bank is fairly valued, it expects improved performance and asset quality to continue to drive earnings upgrades. However, the broker also believes near-term consensus earnings look too conservative, with a 12% effective tax rate presenting one of the more attractive relative returns in the sector.

Citi expects revenue momentum to accelerate in second half 2021, particularly as the loans written in late first half 2021 start to contribute to revenue growth.

As a result, Citi has upgraded cash earnings forecasts by 0.5% in FY21 and 1.5% in FY22, and FY23. To reflect near-term earnings upgrades and improved longer term returns following the improved momentum, Citi’s target price increases to $9.50 from $9.00.

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