Our 2020 top three picks possess strong risk management capabilities and defensive qualities including healthy balance sheets and surplus capital that could be returned to shareholders.

These specialist companies have undergone massive transformation over the years to improve the quality and consistency of their earnings. Our selection comprises two diversified financials (MQG and SUN) and one general insurer (IAG). The operating environment remains positive for MQG (e.g. capitalising on rising global demand for asset management services and infrastructure/green investments) and SUN and IAG (e.g. continuation of volume and rate tailwinds and cost efficiencies backed by adequate reinsurance arrangements). Our 2020 choice of companies also reflect fewer sector headwinds and distractions ahead when compared with the major banks.

MACQUARIE GROUP (MQG)

MQG’s value lies in its ability to manage risk and adapt to changing market conditions. This has allowed itself to transform and push for higher sustainable revenues. MQG is largely a global asset/risk manager with world-class expertise in infrastructure/green investments and broad banking capabilities. These attributes in addition to predominantly lower-risk and higher return annuity-style earnings activities (60% of 1H20 Group net profit contribution, ~24% return on ordinary equity) and capital management flexibility (~$4.9bn surplus capital based on 10.5% RWA) continue to underpin our bullish view. As a lower risk, higher return investment proposition, MQG remains our top sector pick.

SUNCORP GROUP (SUN)

SUN’s top line and cost trends in 1Q20 remain in line with expectations and a higher natural hazard allowance would improve its capacity to deal with catastrophes. SUN is also committed to repricing for higher hazard costs and this adds to its defensiveness. The Capital S.M.A.R.T sale will generate ~$300m excess CET1 capital. Given strong organic capital generation and assuming natural hazards are in line with allowance, another 8¢ special dividend and further return of surplus capital are highly likely in FY20. Longer term, we still expect SUN to divest its sub-scale bank that currently sits on ~$3bn CET1 capital.

INSURANCE AUSTRALIA GROUP (IAG)

IAG is in our view the best pure play general insurer given its better risk-adjusted return profile, cost discipline and very strong reinsurance arrangements. FY20 guidance is for further improvement in underlying performance (based on further premium increases in short tail personal and commercial lines, modest volume growth, ongoing cost discipline and 16-18% reported insurance margin) and was reaffirmed at its recent AGM. Organic capital generation remains strong and the recent sale of its 26% interest in SBI General will boost surplus CET1 capital by $400m and increase the likelihood of a special dividend and/or return of capital in FY20.

Authored by TS Lim – Banks/Insurance Analyst at Bell Potter Securities, 17 December 2019
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Disclosures:
T S Lim holds long positions in IAG, MQG and SUN.