Suncorp: Result 2018

If there's one takeaway from Suncorp's full year result, it's this: management is making good on its strategic promises.

Performance is improving at all of the company's core divisions and the marketplace strategy has posted some early successes. Suncorp is cutting operating expenses, and technology initiatives, such as new customer apps, are going to plan.

We're glad to see the sale of the troubled Australian Life Insurance business. Write-downs and weak earnings have been a regular feature of this division (and life insurers generally). A turnaround would be difficult, so a clean break is the next best thing.

The sale should garner around $725m in proceeds but will catalyse a hefty $880m goodwill write-off. Disappointingly, the sale price is also a large discount to recent peer transactions (based on embedded value). Once the sale completes later this year, shareholders can expect a capital return of around $600m after break-up costs – around 4.3% of Suncorp's total equity.

The good news is that with Life Insurance out of the way, Suncorp can now focus on its more profitable banking and general insurance businesses.

Solid performer

The Australian general insurance division is the company's top earner, accounting for 54% of revenue. While growth was slow this year, Suncorp has a strong competitive position in lucrative product lines.  

Overall, gross written premium – an insurer's measure of revenue – was flat, though performance was wide-ranging between product lines. Motor and home insurance – which account for over 62% of the division's premium earnings – grew 6% and 3%, respectively. In contrast, compulsory third-party premiums fell 17%, reflecting a few costly regulatory changes that are unlikely to be repeated.

Net profit from general insurance was 1% lower than last year at $681m. Insurance results are impacted by all sorts of events and assumptions, so they tend to be volatile. The second half, for example, benefited materially from subdued weather and the modification of some actuarial assumptions. We can't rely on good weather every year, so it's important we don't extrapolate the current results far into the future.

That goes for recent efficiency improvements, too. Suncorp's Business Improvement Program (BIP) is cutting operating costs – which boosts margins – but we're mindful that in the competitive insurance market, Suncorp's rivals are working just as hard to cut costs too. Over the long term, we expect any savings to benefit customers more than shareholders, because premium prices can fall industry-wide following cost-cuts.

Second-tier bank

Unlike the insurance division, Suncorp's bank is a small player and accounts for less than a third of total profits. The business has been a poor performer in the past, so we're glad to see management shake things up.

Still, banking net profit fell around 5% to $375m despite lending up a healthy 6% and the net interest margin stable at 1.84%. Higher operating costs and lower non-interest income (such as ATM fees) were the main culprits.

Suncorp Bank is growing but it's hard to compete with the Big 4 banks, which have a larger pool of deposits, cheaper debt, greater scale and regulatory benefits. That hasn't dampened Suncorp's lending ambitions, with growth exceeding that of the industry (and the Big 4) for home and business lending.

That said, considering the current low provision levels and sky-high housing prices, we're cautious that now may not be the best time for the business to go on a lending spree. Nonetheless, management suggests the high growth will be maintained.

Suncorp's New Zealand operations were this result's star performer. Premiums were up 8% for the financial year, and earnings grew 70% to $148m.

Maintain caution

Overall, this was a good result but it will be tough for management to achieve its target return on equity of 10% next year. Cash earnings would need to rise from $1.1bn to around $1.4bn (excluding life insurance). For that to happen, a lot needs to go right and we're nervous that such lofty targets could lead to management taking unnecessary risks.  

Suncorp has a price-earnings ratio of 15 based on consensus earnings for 2019 and trades at around 2.5 times tangible book value. On the face of it, that may seem reasonable, but the risks mean this stock deserves the extra caution.  

We're raising our recommended Buy price from $8 to $10 to reflect a more favourable view of how the new strategy is progressing, but we'll leave the Sell price unchanged at $16. For investors with a portfolio weighting close to our recommended maximum portfolio weighting of 7%, now may be a suitable time to reduce exposure. HOLD.