And here we are, we have reached the final stop on our progression through the Top Twenty. This week, the companies examined are Suncorp (SUN.ASX) and Scentre Group (SCG.ASX).
Below are the previous articles in this series:
Talking Top Ten | Part 1: The Banks
Talking Top Ten | Part 2: CSL, BHP & Wesfarmers
Talking Top Ten | Part 3: Fortescue, Woolies & Transurban
Talking Top Twenty | Part 4: MQG, Telstra & Rio
Talking Top Twenty | Part 5: Goodman, Newcrest & Woodside
Talking Top Twenty | Part 6: Brambles, Amcor & IAG
If you’ve read last week's summary of IAG, then you’re probably aware of what the numbers might look like for Suncorp. That being said and in all honesty, I was expecting much worse given the headwinds that the insurance industry has been facing without much reprieve for close to eighteen months now. Let’s get through some numbers, NPAT of $913m with cash earnings coming in at $749m. At face-value, the NPAT figure represents an increase of 421.7% or $738m AUD growth from the previous year. But before you get ahead of yourself, those figures were a result of the sale of Capital S.M.A.R.T and the ACM Parts business. A solid move in rationalising the business, which has also previously included the demerger and sale of the Australian life insurance division to TAL Daichi and which recognized a non-cash related loss of $910m AUD. The increase in NPAT this year was, by the way, also largely a result of the one-off recognition of the $899m AUD loss in the previous year as a result of this sale. But that's where the upside stops. Cash earnings, a truer reflection of the underlying health of the company, reflect a drop of 33% from the previous financial year.
This business is a work-in-progress on a massive scale. The previous CEO, Michael Cameron, had been trying to grapple with the strategic direction of the business and launched the much-hyped digital marketplace initiative which was meant to create a local Amazon of sorts for financial services products. The outcome of this is still not evident with many of the new initiatives creating further headaches around what the overall company direction was. When it comes down to it, the business is predicated on selling general insurance products but with a vast range of silos and brands under the umbrella. In researching this summary, I often got the feeling that management didn’t have a clear direction of priorities and what the groups’ overall focus was going to be. The one saving grace in the most recent numbers was that, despite the overall red, GWP (Gross Written Premiums) held steady.
This lack of direction is still clearly evident despite the appointment of a new CEO, Steve Johnston. Shareholders got some reprieve in the declaration of a modest dividend, but this was cash-flow from the sale of bits and pieces of the business. At this rate, next on the chopping board might well be the banking division, though the fact that Mr Johnston comes from a life spent in this particular division might stave off the inevitable. Even here, it has managed to bungle its relationship with mortgage brokers in QLD and has a cost-to-income ratio of about 60%, not to mention a $56bn balance sheet (arguably subscale).
And that brings us to this year with the Covid-related events applying further pressure through higher reinsurance costs, downward pressure on yield in the general insurance business and substantial increases to credit provisioning. The $60m allocated to ongoing pay and leave entitlements was a prudent move
Red Flags & Risks: For me, the biggest red flags and risks when it comes to Suncorp are not so much the macroeconomy factors but what I would say is a clear lack of strategic direction by the company. Dividends might be sustainable but seemingly come at the cost of cannibalising the business. Recent news includes twenty branches being shut down, apparently due to the Covid-19 related “digital shift”. Yet even here, while it might seem to be in the interests of shareholders, what that digital shift might look like is something I would presume only management can know. How this digital shift translates into future organic growth, as opposed to selling off more bits and pieces, is beyond me.
In terms of leadership, after the shock departure of the previous CEO, the replacing with an insider might seem prudent given that Mr Johnston undoubtedly knows the business. This once again leaves much to be desired as it may result in the same lack of strategic direction that long-suffering shareholders are used to.
My Expectations: If I had to choose an insurance business, and that is a rather big ‘if’, I would prefer IAG despite the pain it has been going through. Suncorp, at least on face value, looks rather cheap and minimal market risk (if one defines market risk as the possibility of bankruptcy) given a well-capitalised balance sheet, but it might just get cheaper.
Dividend Yield: 4% assuming a share price of $8.82 AUD.
Given the headwinds that continue to plague both insurance and the broader financial services industry, I would expect the nominal payout to continue falling (unless they cannibalise further) but the yield may just keep getting higher. Let’s see which wins the race, the fall in nominal payout or the fall in share price.
Scentre Group (SCG.ASX)
As expected, locking down an economy and social distancing wasn’t great for shopping centres but Scentre has managed and done so in a disciplined manner. 1H20 Funds Under Operations came in at $363m AUD, which was a stellar result in my opinion. That being said, it was lower than my expectations by about a third but this was understandable given that it was primarily a result of credit charges against rent outstanding. Net operating cash flow was $261m AUD, a good result not only for holding up through turbulent times but indicating that management set suitable expectations and delivered appropriately (guidance of $250m AUD). Recent announcements have indicated a substantial pickup in the recovery. Gross rent in August picked up to $183m AUD, this represents 86% of gross rental billings (the other 14% being on credit at the moment) and is another indication of management’s guidance being both prudent and reasonable. This suggests a strong upward trajectory, July coming in at 82%.
On the negative side, the Statutory result for the six-month period ended June 2020 was a loss of $3.613bnwhich includes an unrealised non-cash reduction in property valuations of ($4,079) million. When it comes to property, I am firmly of the belief that it is the one asset class where cash is king. And in keeping with that belief, the metrics to assess the firm despite the paper losses arising from Covid-19 are FFO (Funds From Operations) to Debt, and Interest Cover. Based on these metrics SCG has continued to deliver a solid performance with FFO to Debt standing at 9.2%, and interest cover at 3.6 times (likely to fall going forward). The issuance of $4.1bn AUD in subordinated hybrids, 50% of 6-year duration and 50% of 10-year duration, should not add to the proforma gearing given the equities risk and is again reducing indebtedness (stemming from my belief that hybrids as an instrument are beneficial to the issuer i.e. equities risk for fixed income returns).
Red Flags & Risks: I am fundamentally of the belief that, despite many doomsday predictions, retail stores will have a place in the shopping experience despite the advent of online and e-commerce. However, key risks include worse-than-expected occupier demand, shortfalls in consumer spending (despite fiscal measures) and cost overruns related to development. Many of the smaller tenants may continue to press for lower rents.
My Expectations: Solid business and good management with a clear vision for delivering shareholder value. Prudent management of balance sheets and I expect consistent growth in earnings as well as a re-rating of the underlying security. A buy from me given the valuation on a historic and forward earnings basis as we see continued recovery and de-leveraging.
Dividend Yield: 9.9% assuming a share price of $2.31 AUD.
Looks prime for a re-rating and has been sold off enough. Management play and based on past performance, expect consistent growth of the nominal payout over the long-term. Fair value at $3.10 AUD (though at the lower end given market cynicism on retail).
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