SUN-nier Times?
Shares of banking and insurance giant, Suncorp (ASX:SUN) have started to bounce back with the recent developments supporting the improving conditions on the company front. The only headwind, it seems, is the shift in the macro narrative towards an inflationary environment. And an inflationary environment does mean higher interest rates which will influence the flow of funds. These developments are likely to influence a good chunk of Suncorp and we intend to review the latest developments in today’s report.
What’s new?
In our last coverage of Suncorp back in late November (FAT-AUS-1046), we focussed on the group’s then-latest trading update which showed improving momentum, especially in its home loan portfolio. We also saw early signs of growth with the new strategy seemingly working while a strong housing market provides another complementary boost. The only speedbump at the time was the ‘hail and wind’ event at the close of October.
Since then, there has been a couple of updates starting with the completion of the sale of its 50% interest in RACT Insurance to its joint venture partner, the Royal Automobile Club of Tasmania Ltd (RACT), which was announced at the start of July 2021. As a recap, the sale was for a total cash consideration of $83.75 million and is part of Suncorp’s efforts to simplify its business model.
Along with the announcement, Suncorp (ASX:SUN) disclosed that the pre-tax profit on sale is $65 million, with the total capital release as a result of the transaction being $55 million. The $65 million pre-tax profit was at the low end of its guidance of between $65 million to $70 million. However, the total capital release was only expected to be approximately $50 million which we believe to be the more salient point as this will dictate how much funds are available for redeployment.
At the time of the sale, Suncorp’s CEO Steve Johnston said that the transaction was in the best interests of customers, shareholders and the business and said that “Suncorp and RACT have enjoyed a successful relationship in Tasmania since 2007. We have mutually agreed that now is the right time for RACT to take full control of the insurance entity. This is consistent with our focus on simplifying the group and driving improvement in our core insurance and banking businesses.”
We concur with his view as the divestments of RACT Insurance (and previously, its wealth management business) make strategic sense with Suncorp having scale economies in the core businesses. This should also free up management attention to focus more on Suncorp’s wholly owned brands such as leading national mass market brand AAMI, as well as the more specialised brands Shannons and APIA.
We’re pleased to see prudent deployment of capital for Suncorp, case in point is FY21’s where due to its “strong” balance sheet and management’s confidence in the outlook, the Board declared a fully franked final dividend of $0.40 per share, a $0.08 per share fully franked special dividend and announced an on-market share buyback of up to $250 million. The total FY21 ordinary dividend of $0.66 per share represents a trailing grossed-up dividend yield of 6.0% at the current Suncorp share price.
Management also confirmed that they will continue to maintain the current capital management strategy, including an appropriate buffer. Management is maintaining their commitment to a dividend payout ratio of between 60% to 80% – all pleasing figures for income investors. Pleasingly, as a vote of confidence came from the S&P Global Ratings agency which upgraded Suncorp’s credit rating profile from A+ to AA- with a Stable outlook. This goes to show that management continues to perform well and has maintained sufficient capital adequacy despite the difficult economic environment (think: COVID-19).
On the subject of a tough economic environment, the macro narrative of 2022 is now shifting from one of easing and low rates to an inflationary and rising benchmark rates. The consequences of COVID-19 and years of quantitative easing have seemingly caught up with the levers of monetary policy no longer as effective in getting the ‘system’ to act while lockdowns and restrictions worldwide have resulted in a major disruption in the supply chain of the world – the latter being the major cause of inflation this time around.
That said, the capital markets worldwide have now priced in circa 3 to 4 rate hikes with some room for more this 2022 and spurred on by the fact Fed Chair Jerome Powell is using increasingly ‘colourful’ (relatively speaking, of course, for a regulator) language. For typical banks, rate hikes following a long period of low rates means that their NIMs (net interest margins) are likely to be squeezed as their costs to lend (i.e. based on the latest rates) would be higher vis-à-vis their revenue (i.e. their low-rated portfolio of loans). We don’t think this to be the case for Suncorp (ASX:SUN) as it can benefit in key areas such as its home, personal and commercial loan offerings. The fact that it also operates as an insurer also would give it the benefit of better Motor Insurance performance with substantially fewer accidents due to COVID-19.
Still, this is largely conjecture but the sky does seem ‘sunnier’ for Suncorp (ASX:SUN). We’re looking forward to how it would perform this year with management committing to focus on driving improved momentum in the core business, in order to meet its FY23 plan to deliver a growing business with a sustainable return on equity that’s above the cost of equity.
Suncorp (ASX:SUN) Group will remain firmly held in the Fat Prophets portfolio. We recommend the stock as a buy for Members without exposure.
