SUN's acquisition of Promina made it the second-largest domestic general insurer and the group has a large regional banking franchise in Queensland. The integration of Promina and extraction of cost synergies have gone well. SUN's future now lies with the domestic insurance cycle, synergies with Promina, the fortunes of the banking business and, potentially, M&A. SUN is only a second-tier investment for long-term portfolios given the defensive motivation for acquiring Promina and the lack of meaningful revenue synergies, as well as the greater appeal of alternative banking, insurance and wealth management pure plays. The banks above-average exposure to commercial property is a risk to earnings. At best the stock should trade in line with its sectors. General insurance is a high-risk business. Large insured events occur without warning and claims trends are largely beyond the control of management in the short term. The decline of SUNs surplus long-tail reserves is a risk to its ability to smooth profits when major claims events occur. Reinsurance protection mitigates the risk to some extent.
Event05-Feb-2009 SUN today pre-released key details of its 1H09 result, also launched a $900m-$1.3bn equity capital raising at $4.50 per share, and announced the departure of CEO John Mulcahy. 1H09 NPAT should be $250-270m, or $210-230m if SUN loses a dispute with one of its reinsurers.
Business Impact: The NPAT guidance is up to 45% below 1H08 and dramatically below market consensus for the full year, even the $750m bottom end of the range. Full-year dividend guidance is just 40c, split evenly between the halves. This is 63% below pcp! A major equity raising at $4.50 and the drastic cut to the dividend are disastrous outcomes for existing shareholders. SUN’s share price was already back to March 2000 levels but $4.50 is a whole new nadir. Major bank stocks have halved but at $4.50 SUN will be down nearly 80% from its $21.94 peak. And the stock will probably come back on lower than the raising price if experience with other recent capital raisings is any guide. Shareholders are paying a terrible price for the bank’s pursuit of the commercial property development sector and underprovisioning in banking and general insurance. The CEO is paying the ultimate price for the investment tragedy this stock has become.
Forecast Impact: --
Recommendation Impact: Pending further analysis we will keep our Sell rating.
Event Analysis All the chickens come home to roost SUN today pre-released key details of its 1H09 result, also launched a $900m-$1.3bn equity capital raising and announced the departure of CEO John Mulcahy. 1H09 NPAT should be $250-270m, or $210-230m if SUN loses a dispute with one of its reinsurers. This is up to 45% below 1H08 and dramatically below market consensus for the full year, even the $750m bottom end of the range. We were towards the bottom end with $900m for the full-year but this has had to come right back. Full-year dividend guidance is just 40c (pcp 107c), split evenly between the halves – again dramatically below our former 75c forecast. A 20c interim dividend would be 60% below pcp!
The bank 1H09 pretax profit should be $90-100m, with good underlying profit growth to be offset by higher impairment charges on commercial property development, Babcock & Brown and an economic overlay for broader bad debts in the recession. The underlying profit growth derives from wider net interest margins and solid operating cost control. Lending for the full year should be flat as SUN reduces lending in ‘non-core’ segments.
The insurance company 1H09 pretax profit should be $240-260m, or $180-200m if SUN loses a dispute with one of its reinsurers. The insurance margin should be respectively 4.5-5.5% or 3-4%. Gross written premiums improved 5.9% to $3.3bn – nice. SUN is succeeding at passing on the costs of recent severe weather claims and commercial lines premiums are finally hardening. Claims for major weather events were $180m in the first half, above allowances for $120m. Plunging discount rates increased the valuation of outstanding claims by $550m and widening credit spreads detracted $200m from investment income on technical reserves. At least all equities were sold from shareholders’ funds in the first quarter.
Wealth management 1H09 earnings should be $120-140m, with strong life insurance sales and cost control offset by falling funds under management.
The capital raising SUN will raise at least $900m through a variety of underwritten measures. It plans to place $390m worth of shares at $4.50 apiece - a 35% discount to its last traded price of $7.13. It will also conduct a 1-for-5 underwritten institutional entitlement offer to raise $410m and will raise $100m through an underwritten dividend reinvestment plan. The entitlements are non-renounceable. It also plans a retail offer, which could push the total proceeds of its capital raising initiatives to $1.3bn. All new shares issued will not be eligible for the interim dividend. A major equity raising at $4.50 and the drastic cut to the dividend are disastrous outcomes for existing shareholders. SUN’s share price was already back to March 2000 levels but $4.50 is a whole new nadir. Major bank stocks have halved but at $4.50 SUN will be down nearly 80% from its $21.94 peak. And the stock will probably come back on lower than the raising price if experience with other recent capital raisings is any guide. Shareholders are paying a terrible price for the bank’s pursuit of the commercial property development sector and underprovisioning in banking and general insurance. Last year SUN rejected offers to buy its bank. We might never know the prices offered but one wonders if they might have diluted shareholder value less than the current outcome. The raising will take banking tier 1 capital to 10.9%. This is exceptionally strong and should be enough to see the bank through the recession.
The departure of the CEO John Mulcahy is paying the ultimate price for the investment tragedy this stock has become. One of the crucial lessons for investors from the SUN saga is to avoid stocks where the management uses spin. Reality always catches up with spin. Apart from the costly overweighting in commercial property development and underprovisioning in general insurance, management’s model of three different financial services in one house has added little or no value as far as we can tell and the acquisition of Promina has consumed huge management resources while adding no more value than the ordinary cost savings which are part of any merger. The new CEO needs to break up the company and let banking, insurance and wealth management pure plays add more value than SUN will be able to.
SUN Price at posting:
$5.31 Sentiment: None Disclosure: Not Held
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