Snowball gathers momentum

Suncorp CEO Patrick Snowball recently oversaw his first set of full year results since he took up the position in September last year. The fact that Suncorp’s earnings came in ahead of the market’s expectations made his job that much easier. Although there is still a long way to go, his leadership is certainly taking the bancassurer in the right direction and this has seen a reduction in the perceived level of risk attached to the stock.

As Members may recall, Mr Snowball moved fairly swiftly following his appointment to outline his priorities for Suncorp. These were to simplify, strengthen and stabilise the business, appoint a new senior team and to provide a clear strategic direction. In achieving these initial objectives, Mr Snowball has laid a firm foundation from which to drive the business forward.

The most critical step was the stabilisation of the business, which was achieved through the segregation of the commercial loan book and other non-core elements of the banking business from the rest of the group. The run-off of the non-core bank’s loan portfolio is proceeding ahead of schedule and overall bank earnings have made decent ground on the long road to recovery. Suncorp’s balance sheet is also in good health, with capital and liquidity levels well above internal targets.

General Insurance

Suncorp is first and foremost an insurance company these days and General Insurance is its most significant contributor to group earnings. As shown in the table above, the division delivered a healthy 34% earnings increase to $557 million and an underlying ITR (Insurance Trading Result) of 9% or $566 million.

The ITR is essentially the difference between premium income and incurred claims and expenses. The underlying figure adjusts for the impact of items such as reserve releases, which can artificially enhance or detract from the ITR. Management expects to lift the underlying ITR to 12% by 2012 and we don’t view this as an overly challenging goal.

Suncorp’s premium grew by 3% through the year. This would be fairly uninspiring growth were it not for the fact that Suncorp exited a number of products during the year. Premium growth came in at 6.5% after adjusting for this.

Motor, Home and Commercial are the most significant product lines within General Insurance, accounting for 35%, 24.5% and 24% respectively.

Motor insurance premium expanded by 6.4% for the year on the back of both higher pricing and sales volumes. There wasn’t a great deal of volume growth across the Home portfolio, but Suncorp still achieved 13.6% premium growth through higher pricing. Commercial was also flat, due primarily to the exit of some business lines.

Suncorp’s ability to achieve premium growth in part through positive price adjustments is encouraging. This is especially so given the number of new entrants in the General Insurance market, thereby demonstrating the strength of Suncorp’s brand.

Meanwhile, Suncorp does not expect to incur material losses related to the New Zealand earthquake that occurred over the weekend. The country has public cover in place for such events and those claims that do flow through to Suncorp should be met by its reinsurance arrangements.

The company’s core Life insurance earnings gained just 1% to $137 million. The Superannuation and Asset Management elements of the Life division did considerably better, delivering growth of 28% and 17% respectively to take overall Life earnings to $192 million.

Bank

The Bank delivered 19% earnings growth from a low base to a still grossly inadequate $44 million. There is of course a stark contrast between the performance of the good and bad banks, which Suncorp chooses to label “core” and “non-core”.

The core bank’s earnings came in at $268 million and there were a number of positives within the result. Suncorp continues to attract deposits at a greater than system pace. The core bank’s deposit to lending ratio sits at a very comfortable 71%.

Australia’s banks rushed to increase deposit based funding after the risk of relying too heavily on wholesale funding was exposed during the credit crisis. Nevertheless, we would not be concerned if Suncorp reduced the weight of its deposit base and this should occur as its core home lending ramps up.

Suncorp’s home lending growth has been below system since January 2009. Such a policy was quite understandable given the need for stabilisation. That time has passed with the non-core bank now under control and management is targeting a return to system growth by the end of this year.

The core bank’s bad and doubtful debt (BDD) expense came in at a comfortable 0.28% of credit risk weighted assets for the year. There was however a significant deterioration in the second half, with a BDD expense of 0.40%. The percentage of past 90 days due loans began to ease from April through to June, however, so we do not view the second half BDD performance as the beginning of a more protracted deterioration.

Management’s focus with regards to the non-core bank is really just about running down its primarily commercial property loan portfolio. The performance to this end has been very good, with the $4.9 billion reduction coming in ahead of expectations.

The quicker Suncorp can rid itself of the non-core bank the better as far as investor sentiment is concerned.

Even so, a bank would not ordinarily like to see its loans repaid ahead of schedule because this reduces the interest income. This is why there are often hefty penalties attached to prepaying a particular loan. This will also be an issue for Suncorp’s non-core bank. The effect of which will combine with a likely higher cost of funding to put downward pressure on the net interest margin in future periods. As we alluded to above though, this is an acceptable price to pay if it more quickly frees Suncorp from the non-core millstone.

Summary

The primary take-away from Suncorp’s result is that the worst is in the past and there is no reason to doubt that Patrick Snowball’s strategic vision is achievable. With the company getting back to its core competencies we would expect to see a sustained double-digit recovery in Suncorp’s earnings over the next few years. In light of which, the company’s current valuation at around 11 times consensus 2011 earnings is far from demanding.

Indeed, the ratio falls into single digits relative to consensus 2012 earnings. In the meantime, the stock provides a healthy dividend yield in excess of 5%.

Turning to the charts and the higher lows represents buyers’ commitment in driving prices higher. In addition, the relative strength index (RSI) is also strengthening which is supported of the move. Overhead resistance lies at the downtrend line around the $8.97 region (3 cents shy of the psychological $9.00 level). A sustained break above this region could potentially see a swift move towards the $9.20 to $9.40 vicinity.

From the weekly chart, consolidation remains the main theme. Support is located at the 39 week moving average (green line) at $8.53, which should result in a move higher to test the upper boundary at $9.59 over the coming months.

Suncorp will remain firmly held in the Fat Prophets Portfolio.