Suncorp: Interim result 2019

We've been skeptical of Suncorp's target of reaching a cash return on equity of 10% this year. And with little growth, margins under pressure and stubborn costs, it still looks unlikely to be achieved in the next few years as well.

Insurance is Suncorp's largest division, accounting for around 55% of group revenue. The business has a strong market position in Australia, particularly in lucrative retail classes, such as car and home insurance, with brands such as AAMI and GIO.

Gross written premiums (GWP) have been growing recently due to price rises - but unfortunately, those same price rises have partly meant that Suncorp has been losing market share in car and home insurance.

In the first half, GWP grew 2.4% to $4.1bn compared to the prior corresponding period, while Suncorp's largest competitor, IAG, managed to increase GWP by 4.2% to $5.6bn.

Margin pressure

Growth should improve over time but it's likely to be at the expense of prices and underlying margins. The latter in particular look like they may be boosted by some optimistic claims assumptions, which have been running below actual claims costs for several years.

It happened again this half as storms hit Sydney late last year. Suncorp's insurance trading margin dropped to 5.2% from 7.3% and earnings declined to $133m from $234m.

The company has now bought more reinsurance, which will reduce earnings volatility but at the expense of a lower underlying margin.

Suncorp is also having a tough time reducing costs across the business, with the current cost-cutting drive being undone by rising expenses in areas such as compliance. The overall impact is that the group's costs are little changed.

A broader problem of cost cuts is that they may end up helping customers rather than shareholders. Rivals are also trimming expenses, so any benefits may be lost to lower prices.

Stagnant bank

Suncorp's banking business, meanwhile, is struggling to compete with the big 4 which have greater scale, lower costs and regulatory benefits.

The lending portfolio grew a meager 2.4% in the half, while earnings dipped 5% to $182m, reflecting a net interest margin of 1.79% (down from 1.82%). Costs came down, but they are well behind targets: the cost-to-income of 56% compares to the aim of 50%.

Despite there being little growth, banking conditions are fair with loan losses near historic lows. Suncorp's impairment charge for the half was just 0.02% of outstanding loans. That will rise at some stage, and if the group is struggling to earn a decent return now, it will almost certainly miss the mark if impairments increase.

The group followed its result by announcing the completion of the sale of its Australian life insurance operations for around $725m. Of that amount, shareholders can expect around $600m to be returned largely through share buy-backs.

Better than 10

Suncorp is a better business than its 10% target return on capital might suggest - even if it's struggling to get there. Although a 10% return aim doesn't appear ambitious at face value, it's made more difficult by the fact that nearly 40% of its book value is made up of goodwill and intangibles from prior acquisitions.

Taking only the regulatory capital needed to support its divisions, Suncorp earns returns of close to 14% on common equity tier 1 capital.

With that in mind, we would be more interested in the company around book value. However, with the price currently at around 1.3 times that value, we are some way from an upgrade. HOLD.