'Oversold' Suncorp should appeal to believers in new recovery measures

Having been sold-off by around 15% since its pre-Christmas warning of lower margins and earnings in 2016 – following $4 billion of weather-related natural disaster claims in 2015, aggressive competition for smaller players, plus a lower Australian dollar (A$) – Suncorp Group (ASX: SUN) appears attractively priced for those who believe its risk management initiatives will deliver the diversified financial company with a significant recovery over time.

What's concerning the market the most is a seismic fall in the group's insurance trading ratio (ITR) – a key measure of profitability – to 10% for the half year to 31 December 2015, and some analysts fear the company will struggle to again reach the ITR of 14.7% it achieved for the full year ended 30 June 2015.

In addition to a weaker A$, the insurer's costs went up 17% on its $500 million parts procurement program in the last couple of years, while low interest rates and excessive volatility in financial markets have staunched returns on Suncorp's investments.

While Suncorp's 10% ITR target is its lowest 2010, any restoration above its targeted 12% would be an extremely good outcome given the current competitive landscape.

Nevertheless, recently appointed CEO Michael Cameron has attempted to reassure investors that key measures, including raising insurance premiums and cost-cutting measures will help to restore the profitability it's experienced in the past. For starters, he expects increased costs to have a significant impact on the underlying margin in Suncorp's personal insurance business. While Cameron has not provided profit guidance, he expects $170 million worth of savings to be delivered by 2018 through the group's optimisation program.

To its credit, Suncorp has not only forewarned the market of what its full year results are expected to look like, but also explained how it plans to restore margins by squeezing its insurance policyholders for more cash. The recent pull-back in Suncorp's share price – now trading at a 30-month low – does appear unwarranted, especially considering its underlying strength of earnings and strong capital position. The stock has strong long term cash flow relative to reported profits, and a long-term funding surplus of 6.1 billion.

While Suncorp's earnings per share (EPS) growth is expected to remain flat over the next 12 months, it is expected to growth from $0.91 in 2016 to $1.00, and $1.02 in 2017 and 2018 respectively. Suncorp is among the biggest buyers of reinsurance in the world, and reinsurance costs did spike by up to 50% in 2011 following the Qld floods and other natural disasters that sparked billions of dollars in claims.

Nevertheless, the stock is well diversified with exposure to three key markets general insurance, life insurance and banking. While the group does derive around 60% of earnings through general insurance, it's important to remember that around 30% of group earnings are also generated through its namesake, Suncorp Bank.

Watch closely for any supporting commentary this reporting season on the severity of recent margin deterioration and any recover of lost ground in the second half of this year, following rate hikes in home and vehicle insurance. Equally important, check whether tightened prices compromise Suncorp's market position – especially within its personal insurance portfolios – when there's more aggressive pricing from new market entrants. Based on a price to book value (P/B) ratio of only 1.09, and a (2016) price to earnings (P/E) ratio of 12.4x, Suncorp does look more attractively priced that its peers.

Adding to the attractiveness of Suncorp at current prices is its projected 2016 fully-franked dividend yield of 6.76%. Suncorp's strong capital position also provides potential for capital returns, enhancing the yield outlook to over 7% in 2017.

Based on target prices above $13, the current price ($11.61) should appeal to those who believe Cameron can restore lost margin and earnings over time.