Going the pure-play route
Investors have ultimately welcomed the decision of Suncorp Group (ASX:SUN) to sell its banking operations to ANZ for $4.9 billion, with Suncorp shares modestly higher than before the transaction was announced. The deal will be subject to the usual approvals and will get a good look from regulators, though we expect the deal to eventually go through. The target timeline provided was approximately 12 months, acknowledging the many moving parts. Should the deal complete as expected, Suncorp Group will become a pure-play insurer focused on Australasia.
Source: Suncorp (ASX:SUN) presentation 18 July 2022
We view the strategic rationale for the transaction positively and the price tag received as decent, being a modest premium to the broader regional banking sector at the time the deal was inked. The cash sale to ANZ for $4.9 billion, represents $1.3 billion of goodwill paid above net tangible assets (NTA) and overall, some 1.3 times NTA. Peers have been trading on the stock market around 0.9x to 1x NTA.
Net proceeds are expected to be around $4.1 billion, or $3.21 per share and the current intention is to return the “majority of proceeds to shareholders” which would be consistent with past smaller sales for the smash repair business and life insurance.
The premium is to be expected for an acquirer, and after Suncorp Bank has staged a solid turnaround in recent years under Clive van Horen. Mortgage approval times have been streamlined dramatically, regaining the support of mortgage brokers, who deliver much of the flow to the bank. Recent lending growth was very good, accelerating in the second half of FY22.
On the other hand, the bank’s technology stack is old and without the muscle of a big bank, further gains in efficiency would have been relatively hard yards for Suncorp, so a sale at a decent price has merit. The bank’s cost-to-income (CTI) ratio has remained stubbornly high, coming in at 59% for FY22, up from 57.1% in FY21. Note the FY22 numbers are unaudited.
Source: Suncorp (ASX:SUN) presentation 18 July 2022
The transaction will leave Suncorp as a pure-play insurer. While insurance is a complex enough endeavour, banking was growing in complexity due to more regulatory oversight and other obligations in the wake of the Haynes Royal Commission, so being part of a bigger group will be more cost-effective for those challenges. Suncorp should no longer receive a conglomerate discount as a pure-play, although that will also tighten market focus on the insurance performance.
The relative simplification of the group should enhance management’s ability to improve the underlying insurance performance, a requisite development for Suncorp to unlock the upward re-rating potential we believe the stock has and to narrow a valuation discount to Insurance Australia Group (IAG).
Summary
Suncorp (ASX:SUN) will continue to run Suncorp Bank in the meantime and the transaction still has several hurdles to overcome, though we ultimately expect it to go through. Suncorp management has indicated the insurer will place even more emphasis on the digitisation drive that has been paying off in recent years. The company will also continue campaigning for sustainable solutions for the industry to climate change, with the frequency and scale of natural catastrophes in recent years adding to the urgency. With Suncorp likely to be on the hook for about $1.1 billion in natural catastrophe costs this year, the insurance business continues to face stiff headwinds. In recent prior coverage we did note although natural events cadence has continued at high levels a firming premium cycle provides support, as does the tightening cycle, which can bolster investment income materially going forward. Suncorp is set to report full year results on 8 August, and we will see the full extent of recent events on the insurance business then.
The market is already quite downbeat on the prospects of Suncorp to improve underlying performance in the insurance business, which we believe in part is justified due to climate change headwinds. However, we have seen some underlying improvement from the digitisation drive and this along with the simplification of the business, firming premiums and higher yields to support investment income provides the ingredients for Suncorp (ASX:SUN) to regain some investor confidence and drive an upward re-rating over time.
Suncorp Group (ASX:SUN) will remain held in the Fat Prophets portfolio. We recommend the stock as a buy for Members without exposure and a medium-term time frame.
The upcoming results will likely be a catalyst in either direction for the stock and the more conservative approach would be to wait for these results before making decisions given we expect the market to be in an unforgiving mood for any disappointments this earnings season.
