Suncorp Group Ltd?s (ASX: SUN) yield of 5.5% is 130 basis points higher than the ASX?s yield. For some investors, this will be enough to merit a purchase from an income perspective. However, in my view the real appeal of Suncorp lies in its scope to raise dividends in future years.
A new operating model
A key reason for Suncorp?s dividend growth potential is its ?One Suncorp? strategy. In my opinion, the strength of this strategy lies in its simplicity. Suncorp is in the process of removing structural constraints between its divisions to create one company as opposed to separated banking,…
Suncorp Group Ltd’s (ASX: SUN) yield of 5.5% is 130 basis points higher than the ASX’s yield. For some investors, this will be enough to merit a purchase from an income perspective. However, in my view the real appeal of Suncorp lies in its scope to raise dividends in future years.
A new operating model
A key reason for Suncorp’s dividend growth potential is its ‘One Suncorp’ strategy. In my opinion, the strength of this strategy lies in its simplicity. Suncorp is in the process of removing structural constraints between its divisions to create one company as opposed to separated banking, wealth management and insurance divisions. This will create cross-selling opportunities since Suncorp is dovetailing the move with a new digital marketplace which allows its customers to buy a range of financial products online.
The new strategy sounds obvious, but in my opinion it will generate efficiencies in addition to higher sales. Greater collaboration between divisions is a likely end result from the reorganisation which could depress Suncorp’s cost base. Further, partnerships with third parties such as Trōv will enhance customer loyalty and may lead to higher margins in the long run.
As well as higher sales prospects, Suncorp is set to successfully manage its cost base. It expects to deliver a flat cost base in financial years 2017 and 2018 through pooling resources and leveraging its scale, buying power and supplier relationships.
Beyond this, I believe there is scope for further cost reductions. Progress on this front was evident in the 2016 financial year. For example, Suncorp’s General Insurance segment reduced total operating expenses by 1.9% and improved its operating expense ratio to 22% versus 22.6% in the prior year. Suncorp’s Banking segment reduced operating expenses versus the previous period and achieved a cost/income ratio of 52.5% even after absorbing investment into strategic initiatives.
Suncorp intends to maintain a payout ratio of between 60% and 80% of cash earnings. In my view this is an optimum level since it allows for reinvestment in its growth strategy alongside some flexibility should the challenging trading conditions within the Banking segment continue.
Suncorp’s payout ratio was at its maximum level of 80% in financial year 2016. Although there is little scope for a rise in dividends above the pace of earnings growth, over the next two years Suncorp is forecast to increase its earnings by 18%. Alongside a policy of returning excess capital to shareholders, I feel this indicates that Suncorp’s investors will share in its future financial success through higher dividends.
Other financial services stocks such as Commonwealth Bank of Australia (ASX: CBA) and Westpac Banking Corp (ASX: WBC) have higher yields than Suncorp. They yield 5.9% and 6.3% respectively. However, Suncorp’s reorganisation and potential for cross-selling, as well as its cost saving initiatives make me positive on its dividend growth prospects. Therefore, I believe that it is a must-have income stock.
Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
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