Suncorp Group - Morgans

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Insurance - Composite│Australia│Equity research│February 15, 2018. IMPORTANT DISCLOSURES ... the Australia general
Insurance - Composite│Australia│Equity research│February 15, 2018

Suncorp Group Glass half empty or half full

ADD (previously HOLD) Current price: Target price: Previous target: Up/downside: Reuters: Bloomberg: Market cap:

A$13.00 A$14.31 A$14.46 10.1% SUN.AX SUN AU US$13,249m A$16,848m US$31.72m A$42.71m 1,277m 100.0%

Average daily turnover: Current shares o/s Free float: Price Close

Relative to S&P/ASX 200 (RHS)

15.50 15.00 14.50 14.00 13.50 13.00 12.50 12.00 20

116.0 112.4 108.9 105.3 101.7 98.1 94.6 91.0

■ The result disappointment was a ~2% decline in SUN’s underlying insurance margin (ITR) which was larger than expected.

■ Management, however, are forecasting a strong recovery in earnings from here. We think FY19 guidance for a group underlying ITR above 12% is achievable.

■ We lower FY18F EPS by 12%, but make nominal changes to future year earnings. We move SUN to an ADD recommendation, PT A$14.31. Trading on ~13x FY19 PE, a 5 PE point discount to IAG, we see some value now.

Result Summary SUN’s 1H18 cash NPAT of A$472m was ~8% below consensus of A$511m (Morgans estimate A$532m). The 1H18 dividend of 33cps was slightly above consensus of 31cps. Broadly, SUN’s bank, NZ and life insurance results were largely as expected, however the Australia general insurance (GI) profit was well below expectations. The driver of this was a rise in net incurred claims costs, which lowered SUN’s group underlying ITR to 9.4% (ex Business Improvement costs) from 12% in 2H17.

Glass half empty view

15 10

Vol m

■ SUN’s 1H18 cash NPAT of A$472m was ~8% below consensus (A$511m).

5 Feb-17

May-17

Aug-17

Nov-17

Source: Bloomberg

Price performance Absolute (%) Relative (%)

1M -3.6 -0.8

3M -6.8 -6.4

12M -4.6 -6.3

The size of the decline in SUN’s underlying ITR certainly caught us by surprise. While some factors were expected like higher natural hazard budget costs and others explainable, e.g. CTP reform costs, SUN’s ITR performance was poor compared to IAG’s ~1.5% improvement over 1H18. In our view, the key SUN ITR delta was a rise in GI operating expenses (ex BIP), which took ~1.2% off the margin (~A$50m). While we understand ~A$35m (0.7%) of these expenses are unlikely to reoccur (e.g. DAC, some regulatory imposts), they do raise some concerns on potential hidden SUN cost pressures.

Richard COLES

Glass half full view

T (61) 2 9043 7911

SUN management gave usually detailed guidance parameters for FY19. These pointed to a strong recovery in SUNs ITR to above 12% (and also a solid 2H18 uplift), while indicating the bank cost-to-income ratio would retract to ~50% (1H18 ~55%) on BIP benefits. We see a clear trajectory for SUN’s ITR to recover from here, ex-unforeseen factors, driven by solid recent price increases, the non-repeat of some 1H18 costs, and substantial BIP net cost benefits emerging (A$229m in just 2H18/FY19). Positively management also indicated they have made large improvements in dealing with Australian motor claims inflation, a significant recent problem area.

E [email protected]

Changes to forecasts and investment view We downgrade SUN FY18F EPS by ~12%, but make nominal changes to future year earnings forecasts. Our price target is downgraded by 1% to A$14.31 with earnings changes offset by a valuation roll-forward. We move SUN to an ADD recommendation. While acknowledging the flaws into today’s result, we think this is the ITR low point. Significant reinsurance protections also support SUN’s 2H18 result and with SUN trading on ~13x FY19 PE (a 5 PE point discount to IAG) we see some value now. Financial Summary Gross Written Premium Net Premium (A$m) Cash Net Profit (A$m) Normalised EPS (A$) Normalised EPS Growth FD Normalised P/E (x) DPS (A$) Dividend Yield P/BV (x) ROE (%)

Jun-16A 7,803 6,893 1,089 83 -9.0% 15.6 68.0 5.2% 1.2 8.1%

Jun-17A 8,111 7,072 1,145 88 5.3% 14.8 73.0 5.6% 1.2 8.4%

Jun-18E 8,288 7,541 1,045 79 -10.3% 16.5 67.4 5.2% 1.2 7.6%

Jun-19E 8,620 7,779 1,349 101 27.8% 12.9 77.7 6.0% 1.2 9.6%

Jun-20E 8,878 8,012 1,459 109 7.9% 12.0 83.8 6.4% 1.2 10.2%

SOURCE: MORGANS ESTIMATES

IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP

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Insurance - Composite│Australia│Equity research│February 15, 2018

Figure 1: SUN Financial summary A S X c o de :

S UN S ha re pric e ( A $ ) :

No . o f skares (m): M arket cap (A $ m):

1,278 Reco mmendatio n: 16,609 Valuatio n:

$ 13 .0 0 A DD $ 14.31

G e ne ra l Ins ura nc e Gro ss Written premium

7,803

8,111

8,288

8,620

P rice target:

$ 14.31

Net earned premium

6,893

7,072

7,541

7,779

8,012

Upside/(do wnside):

10.0%

Net incurred claims

(5,099)

(4,923)

(5,445)

(5,583)

(5,860)

14.8

Operating expenses

(1,379)

FY18F P E Ke y f ina nc ia ls Repo rted NP A T (A $ m)

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

1,310

1,424

1,038

1,075

1,004

gro wth (%)

-8.4

3.6

-6.7

CA SH NP A T

1,089

1,145

1,045

1,349

gro wth (%)

-8.6

5.2

-8.8

29.2

EP S - Repo rted gro wth (%) Cash EP S - pre NRI & A dj. (A cps) gro wth (%)

79.6 -8.5

82.6 3.8

83.3

-8.4

87.8

78.7 -10.3

29.2 100.6 27.8

1,459 8.1 105.9 8.4

F Y 18 F

F Y 19 F F Y 2 0 F 8,878

(1,411)

(1,442)

(1,561)

(1,416)

236

205

202

181

256

Insurance Trading Result

619

912

738

961

1,029

Other inco me

71

65

97

73

106

690

977

835

1,034

1,135

Inco me tax

(200)

(288)

(239)

(296)

(325)

G e ne ra l ins ura nc e pro f it a f t e r t a x

490

689

596

738

8 10

68

34

55

55

60

558

723

651

793

870

1,378

P ro fit befo re tax

Lif e ins ura nc e pro f it a f t e r t a x Ins ura nc e pro f it a f t e r t a x

108.5 7.9

B a nk ing & We a lt h

68.0

73.0

67.4

77.7

83.8

Net interest inco me

P ayo ut ratio - P re NRI/Other A dj (%)

81.6

83.2

85.6

77.2

77.2

Net no n-interest icno me

Franking (%)

100

100

100

100

100

0

0

30

30

30

P ric ing m ult iple s

5.3

97.7

8.7

F Y 16 A F Y 17 A

Investment inco me - insurance funds

DP S (c)

Tax rate (%)

-9.0

75.6

30.6

P ro f it & lo s s ( A $ m )

1,129

1,131

1,214

1,299

88

76

68

72

78

(639)

(636)

(691)

(698)

(733)

P ro fit befo re impairment lo sses o n lo ans and advances 578

571

591

674

723

Impairment lo sses o n lo ans and advances

(7)

(28)

(43)

(64)

Operating expenses

B ank pro fit befo re tax

(16)

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

562

564

563

631

659

P rice/earnings ratio (x)

16.3

15.7

17.2

13.3

12.3

Inco me tax

(169)

(168)

(168)

(189)

(198)

Cash P /E

B a nk pro f it a f t e r t a x

393

396

395

442

461

25

4

12

12

12

4 18

400

407

454

473

N e w Z e a la nd Gro ss Written premium

15.6

14.8

16.5

12.9

12.0

P rice/bo o k value (x)

1.2

1.2

1.2

1.2

1.2

We a lt h pro f it a f t e r t a x

P rice/NTA (x)

2.2

2.1

2.1

2.0

1.9

B a nk ing & We a lt h pro f it a f t e r t a x

Dividend yield (%)

5.2

5.6

5.2

6.0

6.4

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

1,228

1,345

1,419

1,525

1,617

1.3

Net earned premium

1,045

1,099

1,138

1,224

1,297

Ke y ra t io s - re t urns Return o n A ssets

1.1

1.1

1.0

1.2

Repo rted ROE (%)

7.7

7.9

7.3

9.4

9.9

Net incurred claims

(562)

(693)

(631)

(707)

(763)

Cash ROE (%)

8.1

8.4

7.6

9.6

10.2

Operating expenses

(338)

(366)

(362)

(346)

(354)

18

13

11

10

13

163

53

157

180

194

Investment inco me - insurance funds Ke y ra t io s - A us t ra lia

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

Gro ss written premiums (%)

n/a

3.9

2.2

4.0

3.0

P ro fit befo re tax

Net earned premiums (%)

n/a

2.6

6.6

3.2

3.0

Inco me tax

Life in-fo rce gro wth (%)

0.0

(0.9)

0.2

1.5

1.6

G e ne ra l ins ura nc e pro f it a f t e r t a x

74.0

69.6

72.2

71.8

73.1

Co mmissio n ratio (%)

13.1

12.8

12.8

11.3

10.3

Expense ratio (%)

7.3

7.6

7.9

6.9

6.9

94.4

90.0

92.9

90.0

90.4

Other pro fit (lo ss) befo re tax

GI Insurance margin (%)

9.0

12.9

9.8

12.4

12.8

Inco me tax

Life planned pro fit margin to average info rce - %

0.0

2.3

3.0

2.5

2.6

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

G ro wt h

Other inco me

M a rgins Claims ratio (%)

Co mbined ratio (%)

Ke y ra t io s - N Z

Insurance Trading Result

Lif e ins ura nc e pro f it a f t e r t a x

G ro wt h

N Z pro f it a f t e r t a x P ro f it a f t e r t a x f ro m bus ine s s line s

O t he r pro f it ( lo s s ) a f t e r t a x C ash N P A T A cquisitio n amo rtisatio n (after tax)

Gro ss written premiums (%)

n/a

9.5

5.5

7.5

6.0

Net earned premiums (%)

n/a

5.2

3.6

7.5

6.0

Life in-fo rce gro wth (%)

n/a

7.0

5.7

5.6

5.5

M a rgins

R e po rt e d N P A T C a pit a l R a t io s

10

6

17

18

63

163

198

212

(51)

(18)

(51)

(62)

(66)

13 4

45

112

13 6

14 5

49

37

30

33

36

18 3

82

14 2

16 9

18 2

1,15 9

1,2 0 5

1,2 0 0

1,4 15

1,5 2 5

(76)

(58)

(62)

(62)

(62)

6

(2)

49

(4)

(4)

(70)

(60)

( 15 5 )

(66)

(66)

1,0 8 9

1,14 5

1,0 4 5

1,3 4 9

1,4 5 9

(51)

(70)

(41)

(39)

(35)

1,0 3 8

1,0 7 5

1,0 0 4

1,3 10

1,4 2 4

F Y 16 A F Y 17 A

F Y 18 F

F Y 19 F F Y 2 0 F

B a nk ing

Claims ratio (%)

53.8

63.1

55.4

57.8

58.8

CET1ratio

Co mmissio n ratio (%)

23.0

23.3

22.4

19.9

18.9

To tal capital ratio

Expense ratio (%)

21 185

9.2

9.2

9.0

9.0

9.1

13.5

14.6

13.3

13.2

13.2

9.4

10.0

9.4

8.4

8.4

GI Insurance margin (%)

15.6

4.8

13.8

14.7

14.9

G e ne ra l Ins ura nc e

Life planned pro fit margin to average in-fo rce - %

55.9

13.1

12.9

12.9

12.9

CET1ratio (x)

1.21

1.32

1.20

1.23

1.30

P CA Ratio x

1.67

1.77

1.62

1.63

1.69

346

377

88

214

410

Ke y ra t io s - T o t a l Ins ura nc e

F Y 16 A

F Y 17 A

F Y 18 F

F Y 19 F

F Y20F

Gro ss written premiums (%)

n/a

4.7

2.7

4.5

3.5

Net earned premiums (%)

n/a

2.9

6.2

3.7

3.4

Life in-fo rce gro wth (%) M a rgins

n/a

0.9

1.5

1.8

2.6

G I Ins ura nc e m a rgin ( %)

9 .9

11.8

10 .3

12 .7

13 .1

Underlying ITR (%)

10.6

11.5

10.7

12.0

12.7

4.8

4.8

5.3

5.1

5.2

G ro wt h

Life planned pro fit margin to average in-fo rce - %

G ro up Excess CET1capital (A $ m) P e r s ha re da t a Spo t no . o f shares (M ) B V per share (A $ ) NTA per share (A $ )

F Y 16 A F Y 17 A F Y 18 F F Y 19 F F Y 2 0 F 1,278 1,285 1,289 1,289 1,289 10.6

10.7

10.7

11.0

11.2

6.0

6.2

6.2

6.5

6.8

V a lua t io n a s s um pt io ns Ke y ra t io s - B a nk ing Lo an gro wth (%) Interest M argin (%)

F Y 16 A F Y 17 A 4.5 1.9

F Y 18 F F Y 19 F F Y 2 0 F 8.7 7.0 6.8

M e t ho do lo gy: S um o f pa rt s v a lua t io n

SOT P s

1.9

1.8

1.9

1.8

1.8

Co st To Inco me Ratio (%)

52.5

52.7

53.9

50.9

50.4

Co re B ank (P E multiple)

5,165

$ 4.02

12.0

B DD/A verage Gro ss Lo ans (%)

0.03

0.01

0.05

0.07

0.10

General Insurance (P E)

11,762

$ 9.15

12.0

1,822

$ 1.13

15.0

18 ,3 8 2

$ 14 .3 1 0.0%

Wealth M anagement (NTA ) G ro up E xpe ns e s Gro up Expenses (A $ m) Gro wth (%)

F Y 16 A F Y 17 A (2,669) (2,746) n/a

1.2

F Y 18 F (2,884) 6.6

F Y 19 F F Y 2 0 F (2,720) (2,709) 0.2

3.5

T o tal Disco unt (%) P ric e t a rge t

A$ m

A $ ps Im plie d F Y 18 F P E

$ 14 .3 1

SOURCE: MORGANS ESTIMATES

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Insurance - Composite│Australia│Equity research│February 15, 2018

Changes to forecasts and investment view We downgrade SUN FY18F EPS by ~12%, but make nominal changes to future year earnings forecasts. Our price target is downgraded by 1% to A$14.31 with earnings changes offset by a valuation roll-forward. We move SUN to an ADD recommendation. While acknowledging the flaws into today’s result, we think this is the ITR low point. Significant reinsurance protections also support SUN’s 2H18 result and with SUN trading on ~13x FY19 PE (a 5 PE point discount to IAG) we see some value now. Downside risks to our ADD call are; volatile weather particularly on the Eastern seaboard of Australia; 2) rising claims inflation; 3) increased pricing competition and; 4) volatile investment market movements. Figure 2: SUN - Changes to forecasts Total profit from business line Previous forecast Current forecast % change Growth Cash NPAT Previous forecast Current forecast % change Growth Cash EPS Previous forecast Current forecast % Change Growth DPS Previous forecast Current forecast % change Growth

FY16A

FY17A

FY18F

FY19F

FY20F

1,159 1,159 n/c -6.2%

1,205 1,205 n/c 4.0%

1,324 1,200 -9.4% -0.5%

1,403 1,415 0.9% 18.0%

1,469 1,525 3.8% 7.7%

1,089 1,089 n/c -8.6%

1,145 1,145 n/c 5.2%

1,166 1,045 -10.4% -8.8%

1,345 1,349 0.3% 29.2%

1,411 1,459 3.4% 8.1%

83 83 n/c -9.0%

88 88 n/c 5.3%

89 79 -11.5% -10.3%

102 101 -1.4% 27.8%

107 109 1.6% 7.9%

68 68 n/c -22.7%

73 73 n/c 7.4%

75 67 -9.8% -7.7%

79 78 -1.3% 15.3%

82 84 1.6% 7.8%

SOURCES: MORGANS ESTIMATES

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Insurance - Composite│Australia│Equity research│February 15, 2018

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Disclaimer The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual’s relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so. Those acting upon such information without advice do so entirely at their own risk. This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever.

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