Sid Ruttala completes his journey through the ASX 20. This week we visit and review Suncorp (SUN.ASX) and Insurance Australia Group (IAG.ASX), two of Australia's biggest financial services businesses. Although each company services a different part of the financial services sector, this article is an important read for the Australian investor.
The earlier parts of Talking Top Twenty, can be found here:
Part 1: The Banks - CBA & WBC
Part 2: The Banks - NAB & ANZ
Part 3: BHP & Fortescue
Part 4: CSL & Wesfarmers
Part 5: Woolies & Macquarie
Part 6: Telstra & Rio
Part 7: Transurban & Goodman
Part 8: Newcrest & Woodside
Part 9: Brambles & Amcor
Insurance Australia Group Ltd (IAG.ASX)
Since we last examined the ASX 20, IAG has continued to struggle on. Mr Hawkins seems to have transitioned the team well but the business looks rather messy nevertheless, as has arguably been the case across most insurance businesses in the country. Lowe’s recent comments around monetary policy and a ruling out of normalisation until 2024 hasn’t helped. This, combined with flooding in Victoria and increased natural disaster costs, has meant that the share price continues to underperform.
Numbers-wise, there are signs of a turnaround though it is a mixed bag. Gross written potential (GWP) continues its upward momentum both in Australia and New Zealand with an overall increase of 5% and 2.8% respectively. Interestingly, underlying margins have increased to 15.1% for 1H21. Granted, this has been driven by reduced auto-claims through much of last year but it is a good sign nevertheless. Thankfully, the market has also seemed to move-on from the Greensill saga with the business coming out relatively unscathed.
Covid continues to place upward pressure on operating expenses, increasing 7.1%. However, even stripping out Covid, the growth rate would still be in the high single digits; this includes higher compliance/governance costs, reinsurance and higher annual leave provisions. This will be the aspect to watch going forward. At the time of my previous writing, the biggest concern was the widening of credit spreads as well as long-tail classes. To explain this concept briefly (again), these are liabilities of the business, claims incurred but not reported since they take a longer period to settle. Pleasingly, this was mitigated (at least the short-tail) and the business has reported better than expected numbers with rate rises matching claims inflation and increases to commercial rates (i.e. 7%). Cash earnings stood at $462m (21.5% increase) and Diluted EPS came in at 17.88cps for 1H21 (11.9% increase).
I personally remain convinced that selling off the stake in SBI General was a mistake and the business would have been much better off waiting until this year. Their stake would today be worth approximately $832m AUD (it was sold for $600m).
Red Flags & Risks: From a risk perspective, CET1 continues to stand well above requirements. This will be a play on a reversion to normalisation of the rates and fixed income environment. The business carries approximately $11.7bn AUD in investments, 75% of which remains in cash instruments and fixed interest investments with the remainder being spread across alternatives and equities. Any financial suppression (i.e. the forced suppression of real yields) will have a disproportionate impact upon the bottom line.
Given the messiness within the broader business, Suncorp has fared somewhat better than IAG. Unlike IAG, Suncorp’s restructuring has been far more reasonable in my view. The sale of the life insurance and smash repairs businesses should add some returns to the pockets of long-standing shareholders. Nevertheless, like IAG, the business has faced significant headwinds overall including compression in margins and intense competition. Key going forward is insurance margins through cost-outs and further growth through online sales.
Going through the numbers for 1H21, PAT came in at $568m, an increase of 43.4% on a like-for-like basis. NPAT came in at $490m, which represents a decline of 23.7%. This is actually a stellar result as the previous years NPAT would have included the sale of the life insurance business. Importantly, cash earnings continued to grow at a healthy 39.5%. These numbers are great but I remain concerned about top-line growth which will not, in my view, return substantively until 2024. Moreover, the cost to income ratio of 50% seems overly ambitious given performance to date. Suncorp Bank’s footprint across regional areas shows some promise and is a competitive advantage when compared to the Big Four banks. However, 80% of the loan book is primarily residential mortgages with a disproportionate amount (over 50%) in QLD. It is incumbent upon the organisation to place greater emphasis on 1) synergies (between the bank and insurance lines); and 2) increased switching costs. None of these has been accomplished in a meaningful way in my opinion. The sale of the wealth business was the most recent target for no substantive difference to the bottom line.
The key going forward is execution on the bancassurance model, where cross-selling and upselling takes place as well as driving increased customer stickiness. Say, for example, selling a home insurance policy along with a mortgage with incentives to bundle the two together.
Red Flags & Risks: The biggest red flags and risks when it comes to Suncorp (along with the overall macroeconomic factors impacting the insurance market) are strategic and tactical. Management has given ambitious targets for the digital and cost outs. Nevertheless, organic growth seems to be the missing ingredient with continued selling of the family silver so to speak. The new CEO, given his background from a financial perspective (he was the CFO), might be adept at restructuring more efficiently (certainly better than IAG) but this may not translate into top line growth or delivering upon Suncorp’s more ambitious goals.
My Expectations: The business is well capitalised and rather cheap but I remain of the view that IAG offers a much “cheaper” proposition. The business does offer a decent dividend play however.
Dividend Yield: 4.69% assuming a share price of $11.08 AUD.
Disclaimer: Both Suncorp and IAG are owned in TAMIM individually managed account portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.