|Summary: Bank of Queensland is continuing to improve its balance sheet, with an improving return of equity, strong dividend yield and sector-leading earnings-per-share growth. It is trading on a fully franked yield of 5.2%, with an improving return on equity profile.|
|Key take-out: The bank has further upside potential from strong asset growth, margin discipline and further reductions in impairment expenses.|
|Key beneficiaries: General investors. Category: Shares.|
|Recommendation: Outperform (under review).|
Bank of Queensland is one of two pure regional banks listed on the Australian Securities Exchange.
For many years it has been considered a potential takeover candidate, however it has remained independent and occupies a credible position in the marketplace as a challenger brand to the ‘big four’ Australian banks. BOQ is largely focussed on the Queensland market, however it has successfully expanded interstate, mainly through franchised branches.
The bank has a loan book of $35.1 billion, of which 58% of loans are within Queensland, with NSW and Victoria making up another 30%. The BOQ story is one of improving return of equity, strong dividend yield and sector-leading earnings-per-share growth after comprehensively dealing with the legacy issues stemming from the debt-fuelled Queensland property boom and bust over the past decade.
BOQ was overexposed to the speculative nature and excesses of the Queensland property market relative to the size of its balance sheet when the market collapsed during the GFC. This caused substantial problems for the bank, with a long remediation process required. A new CEO, Stuart Grimshaw, was appointed in August 2011 largely to deal with the legacy issues and to move the organisation forward with a reinvigorated strategy. Prior to BOQ, Grimshaw held leadership executive roles at Commonwealth Bank and National Australia Bank.
In early 2012, BOQ recapitalised its balance sheet with a $450 million equity raising. At same time, the bank wrote off many of the under-provisioned legacy loans that had been a drag on BOQ since the GFC. For the 2012 financial year BOQ produced a cash profit of $21 million, which was a decline of 87% from the period before. This figure included a $401 million impairment charge following an asset quality review, including a collective overlay of $160 million. As a result of this equity raising and asset review BOQ now has sector leading capital levels and adequate provisioning levels. The intention of BOQ management was to stabilise and rebase the business from which they could then grow earnings with less volatility.
In 2013 BOQ produced an excellent cash profit figure of $251 million. Features of the result included a reduction in loan impairment expense from $401 million to $115 million, and an improvement in impaired assets from $525 million to $382 million. The balance sheet was strong, with Tier 1 equity of 8.63% and a deposit-to-loan ratio of 68%. Net interest margin expanded from 1.64% to 1.72%.
The opportunity for BOQ
Prior to the GFC, BOQ was considered a high-growth niche bank that traded on a P/E (price to earnings) premium to the rest of the sector, in the band of 14 to 18 times. Currently BOQ is on 12.8 times forward earnings, which is slightly below the sector average. The key to BOQ achieving a higher P/E ratio is its ability to improve return-on-equity (ROE) and demonstrate to the market that it can consistently deliver on growth expectations. ROE is currently only 9%, and I am forecasting that to rise to around 10% in 2014. I expect future years to see a steady improvement in ROE for BOQ.
BOQ has the advantage of growing off a smaller asset base than its ‘big four’ peer group. I see further upside from strong asset growth, margin discipline and further reductions in impairment expenses. Asset growth will be achieved by enhancing distribution channels to grow market share. For example, it acquired Virgin Money in 2013 and is using the mortgage broker channel to complement branch distribution. Currently the impairment expense is around 31 basis points of loans, and management has a target of 20 basis points in 2015.
I also see an opportunity for BOQ to enhance returns to shareholders by reducing its cost base. Currently the cost-to-income ratio for BOQ is still quite high at 44.3%. I anticipate that over time this ratio could move towards 40%.
The Queensland economy is now showing signs of life with tourism picking up and the property market stabilised. Funding conditions for banks in both the deposit and wholesale markets has also improved. A recent upgrade by Standard & Poor’s to A- for BOQ will further help reduce funding costs for BOQ in external wholesale funding markets.
A key risk for BOQ is its inability to compete on a technology offering relative to the major banks. Other risks include its funding disadvantage relative to the ‘big four’ banks due to its lower scale and higher cost in accessing wholesale funding markets. BOQ has a large exposure to the Queensland property market, which tends to move in boom-bust cycles, particularly in areas exposed to tourism and speculative development.
Overall, I forecast high single-digit to low double-digit earnings growth over the next several years for BOQ. It is trading on a fully franked yield of 5.2%, with an improving ROE profile and strong balance sheet. BOQ is a core holding of the Cadence portfolio.
Simon Bonouvrie is portfolio manager at Cadence Capital.
On October 16, 2013, Collected Wisdom reported Bank of Queensland had a consensus neutral rating.