Key Issues
SUN offers an attractive way to play the domestic insurance cycle. SUN’s operational execution has improved in recent years, evidenced by SUN doing a better job of retaining market share vs Insurance Australia Group (IAG). Industry profitability over the last few years have been depressed, following several high-cost claim events.
We expect industry profitability to improve in the coming years; driven by premium rate rises and higher interest rates. At some stage, the elevated claims associated with wetter than average weather along the East coast will also ease, helping profitability.
Long-term forecasts from the BOM suggest the current La Nina weather1 cycle has a >50% chance of recurring for a third year in a row in 2022/23. SUN has lifted its extreme weather cover for FY23.
Pricing power: Domestic insurers are lifting both home (mid-high single digits) and motor insurance (mid-teens, the highest level in 5yrs) premiums – we expect SUN to continue to push through premium increases in FY23E. In prior rate premium cycles, SUN has been able to lift insurance margins to restore profitability.
SUN is reviewing the ownership of the Retail Bank. We value the bank at ~$4bn. The bank lacks sufficient scale to generate higher returns, given its relatively uncompetitive cost of capital. A potential divestment of SUN’s Retail Bank would leave the Group as a pureplay domestic insurer.
Value accretion via divestment is complicated. How much value SUN can create is dependent on; 1) ultimately what price any divestment occurs at (synergies for an acquirer?); 2) the value of any ‘dissynergies’, the most notable being a likely credit rating downgrade.
SUN is currently rated AA-, whilst IAG is A+ by S&P.
Valuation discount vs IAG. Since 2015, SUN has traded on an average PER of 13.0x vs IAG at 15.0x. Closing the valuation gap implies 15% upside to the SUN share price. Divesting the bank could potentially close this gap, although it’s not a certainty. IAG has a larger insurance book which generates a superior margin and return on equity. Justification for a higher multiple.
2023 Outlook. SUN has already provided a range of earnings guidance for FY23, including margins of 10-12%. We see little risk of earnings surprise at the upcoming August result. In contrast, we see both margin and dividend risk for IAG.
Investment view
SUN is the cleanest way to play the recovery in the domestic insurance industry, where profitability has halved in recent years. The industry has been through a rough couple of years following COVID and several large claim events, including the ongoing La Nina weather event.
Rising domestic inflation is giving the industry the ability to put through strong pricing gains to help offset rising claim and reinsurance costs. History suggests that industry can hang on to these price gains once inflation fades. Higher interest rates on SUN’s investment portfolio are likely to be beneficial to earnings in FY23E. SUN has held market share relative to IAG which has been caught up in a range of company specific issues, many of which remain outstanding. Therefore, SUN has been able to provide earnings guidance for FY23E (in contrast to IAG). With earnings and dividend recovery expected in FY23E, SUN trades on PER multiple of 12x, two standard deviations below its long-term average.
On balance, any sale or divestment of the Retail Bank is likely to be viewed positively for SUN. It’s not a must-do deal, and we acknowledge that with SUN trading at just 12x, it’s not as compelling to do vs when SUN is trading at >16x.
Risks to investment view
The business of providing insurance inherently involves the pricing of risk. A wide range of variables including factors outside of the company’s control can have a material influence on both the earnings and capital base of SUN.
Lower than expected insurance premium increases or higher claims inflation could eat into the current expectations of improved earnings for SUN. Higher than expected reinsurance costs could also impact earnings. Higher claim costs caused by the ongoing La Nina weather event (potential for the third year in a row) have the potential to impact 2023 earnings.
SUN is undertaking a review of its Retail Bank. It’s uncertain just how much value a divestment would create.
Increased competition in the domestic general insurance market or accelerated loss of market share could weigh on earnings growth. The market is currently rational in its pricing.
Figure 1: SUN retail bank is sub-scale, whilst delivering slower growth than peers
Source: Refintiv, Sandstone Insight. 5yr CAGR lending book growth 2016-2021.
Figure 2: Domestic insurance industry return on assets remains depressed. We expect returns to improve
Source: APRA, BOM, Sandstone Insight. Red highlights periods of La Nina in Australia.
Figure 3: SUN vs IAG key metrics
Source: SUN, IAG, Refinitiv, Sandstone Insights
Figure 4: SUN’s Insurance business has historically been less profitable than IAG
Source: Suncorp, IAG, Sandstone Insights
Figure 5: PER currently 2 standard deviations below long term average
Source: Refinitiv, Sandstone Insights
Figure 6: PER Rel around the long-term average
Source: Refinitiv, Sandstone Insights
Figure 7: ROE should improve into fy23e. Any sale of bank would provide upside risk to ROE
Source: Refinitiv, Sandstone Insights. Consensus ROE forecast in grey
Figure 8: Dividend yield +6% looks attractive, driven primarily by improved EPS in FY23E
Source: Refinitiv, Sandstone Insights
