Investment view
Regional banking exposure. Over time BOQ has progressively become less QLD centric. Post the ME acquisition in 2021, QLD exposure drops from 42% to 31%. QLD has typically offered stronger growth vs NSW/VIC, but with higher lending over the cycle.
Lacking scale. BOQ’s lack of scale vs the major banks restricts BOQ’s ability to earn outsized returns on equity. This leaves BOQ vulnerable at the bottom of the cycle to generating sub-par returns. BOQ has failed to hold market share over the last decade, seeing its market share of home lending fall from 1.9% to 1.5%, pre-ME acquisition. Members Equity (ME) acquisition lifts market share to 2.4%. 1Q21 acquisition of Victorian-based ME from a consortium of industry super funds for $1.4bn. BOQ paid 1.05x Price to Book (P/B), implying 11.9x PER or 8.0x PER (FY20A) including synergies. The transaction is transformative for BOQ; adds ~1.0% point market share; ~$110m to cash earnings. A $1.4bn equity raising added 30% increase in market cap, and increased shares on issue by 37%.
Did BOQ overpay for ME? The market has remained circumspect of the benefits of ME to BOQ. Whilst additive to scale, EPS accretion is reliant on synergies. The market is currently giving no benefit to any improvement to BOQ’s ROE over the medium term. At the time of acquisition, BOQ had to pay a ~15% P/B premium to acquire ME vs. BOQ’s P/B 0.9x. This now looks like an expensive acquisition relative to BOQ’s current P/B of 0.65x.
Can ME return to prior levels of growth? ME’s growth stalled over FY19-20A primarily due to APRA regulatory issues, which was primarily a function of sub-scale systems. It remains unclear as to whether BOQ ownership will allow ME to return to above-market growth in lending.
Economic cycle/house prices remain the bigger picture. Over the coming 12 months, the primary debate on BOQ will be the impact of lower house prices and lower credit growth on earnings. Both have historically provided a headwind to the BOQ share price in prior cycles.
Hold. Valuation multiples approaching trough cycle levels. BOQ share price has fallen ~35% since late 2021 as concerns around ME, higher interest rates, and a broad sector de-rating across bank stocks have weighed on the share price.
This leaves BOQ trading at ~0.65x P/B, PER of ~8.5x, and a dividend yield of ~7.5%, which historically are close to trough like valuation measures.
A more positive stance on BOQ would require greater certainty on the outlook for rising interest rates, falling house prices and the resulting slow-down in credit growth. BOQ’s historic PER premium to regional peer BEN has now reversed to be at 2.0x PER point discount, suggesting stronger relative value in BOQ vs Sell rated Bendigo and Adelaide Bank (BEN).
Risks to investment view
Upside risks relate to mortgage repricing and stronger than expected levels of credit growth. Better than expected integration and earnings from ME acquisition.
Key downside risks include further deterioration in interest margins, intensifying lending competition, material slowing in credit growth. A significant and rapid fall in house prices driven by higher interest rates would present downside risk to the share price.
