Stock Review

Suncorp shareholders have a new CEO; they should also demand a new board of directors. Our research director examines the case for wholesale change.

Imagine, by some quirk of fate, that you inherited a majority stake in Suncorp on 1 January 2003; of the 528m shares on issue, you owned 300m, or 56.8%. You didn’t want to run the organisation yourself, so you stuck with the previously appointed board of directors whose job it is, in general, to protect your interests. The board is responsible for the key functions set out in Table 1.

Table 1: Selected functions of the Suncorp board

Approve the strategic direction and related objectives for the group

Approve annual budgets, dividend policy and dividend payments

Monitor financial performance and executive management performance in the implementation and achievement of strategic and business objectives

Appoint and remove the Chief Executive Officer (CEO) and ratify the appointment and removal of executives reporting directly to the CEO (senior executives)

Approve the CEO’s performance targets, monitor performance, set remuneration and manage succession plans for the CEO

Source: Suncorp Annual Report, 2008

Since your fortunate inheritance, you’ve simply let the board get on with its job; only expecting reports twice a year and an opportunity to question its performance at an annual shareholders’ meeting. In other words, as a major owner you simply make do with the same amount of information provided to Suncorp’s thousands of smaller minority shareholders. The one big stick you’re willing and able to wield is the ability to appoint or remove directors.

So, with the recent hiring of a new CEO, it seemed like an opportune time to review the board’s performance over the past six and a half years. That is, since it poached former CEO John Mulcahy from the Commonwealth Bank.

Mr Market votes

The fictitious and notoriously moody Mr Market has cast his vote decisively on Suncorp’s performance. Since Mulcahy took the reins on 6 January 2003, the stock price has fallen by more than 40%, compared to a rise of more than 25% in the broader All Ordinaries index.

The share price of your hybrid banking and insurance company (which once described itself using trendy terms like ‘bancassurance’ and ‘Allfinanz’; both of which seem to have been consigned to the corporate jargon dustbin) has also underperformed its peers in both the banking and insurance industries.

Shareholders in National Australia Bank – the worst performer among the Big 4 – have done better than you since Mulcahy’s appointment (losing 33% of their capital value), while insurance peer IAG’s shareholders have seen their share price rise by almost 30% over a period when yours has fallen by that much, and then some.

That’s all rather disheartening. Yet being a student of value investing, you know that a company’s share price can be a poor indicator of its true – or ‘intrinsic’ – value (particularly in the short term). So you decide to stand back and put things in perspective. Dusting off a pile of annual reports, you begin to take a clinical look at what’s been happening in your company over the past six and a half years.

Statistical comparison

In the first instance, you decide to compare some simple statistics; lining up the results for the half year to 31 December 2002 (the last results before Mulcahy took the reins) with the final ones reported under his stewardship, for the half-year to 31 December 2008. You’re hardly impressed by what you find.

Suncorp’s former core business of banking has seen profit go backwards from $150m in pre-tax terms in the 2002 period to just $97m in the December 2008 half, as bad debts soared. That’s disappointing, particularly given the ‘banking expertise’ Mulcahy brought across from Commonwealth.

The now-largest division, insurance, has grown profit from $68m in 2002 to $253m in 2008, following the acquisition of competitor Promina in 2007. And results from the wealth management division were up from $13m in 2002 to a reported $100m in 2008, though almost all of that profit was generated by accounting adjustments related to lower interest rates.

Overall, half-year reported profit after tax is up from $155m to $258m, a compound annual growth rate of 8.9%. That doesn’t look too bad on the surface. But you note that earnings per share have actually gone backwards over the period as shares on issue increased from 528m to 1,013m – growing at an annual clip of 11.5%. And that trend has continued with the group issuing more than 232m additional shares in a discounted capital raising at $4.50 apiece earlier this year, sending the annualised growth rate in shares on issue under Mulcahy to 14.1%.

That growth has meant your holding of 300m shares – a comfortable majority when you inherited it – now represents a stake of just 24.1%. Your teeth begin to grind as you turn to the balance sheet.

Balance sheet metrics

Mulcahy inherited a company with $3.3bn of book value, including $1.2bn of intangibles. Making the appropriate divisions, you calculate the per share numbers for book value and Net Tangible Assets (NTA) to be $6.23 and $3.92 respectively, as at 31 December 2002.

Taking the 31 December 2008 book value of $12.3bn (including $7.1bn of intangibles) and adjusting for the subsequent capital raising (by adding $1.0bn in capital and 232m new shares), you estimate today’s book value and NTA per share at $10.71 and $5.01, respectively. The compound annual growth rates work out to 8.7% and 3.8%.

Table 2: Suncorp key statistics

	31 Dec 02	31 Dec 08	Growth (p.a)
Net profit ($m)	155	258	8.9%
Earnings per share (c)	27.9	26.4	negative
Shares on issue (m)	528	1,013	11.5%
Book value ($ per share)	6.23	10.71	8.7%
NTA ($ per share)	3.92	5.01	3.8%
*Estimated at 30 June 2009, post-capital raising

You’ve always been a fan of tangible assets, particularly for financial firms where capital ratios are important to regulators and credit ratings agencies. So your blood pressure rises further when you consider the sluggish growth rate in NTA per share over the past six and a half years.

Before moving to other matters, you note that the dividend declared for the December 2002 half-year was 26 cents per share, compared to the latest of just 20 cents. In inflation-adjusted terms, you’re clearly much worse off on an income basis. That, along with unimpressive growth in NTA and no growth in earnings per share, indicates that Suncorp’s intrinsic value per share probably hasn’t grown at all in real terms under present management.

Have executives benefited?

You own a much smaller percentage of a larger enterprise but, on a net basis, you conclude that you’re worse off. You’re angry but you’re not an unreasonable person – some investments work out, others don’t. That said, you want to check that your board has ensured that Mulcahy’s empire building hasn’t benefited him and his favoured executives at your expense; you sit down to examine Suncorp’s key executives.

The first key event under Mulcahy’s leadership was an executive shake-up in March 2003. You rule up some columns on a notepad and jot down the key roles as defined by Mulcahy in 2003 and the incumbents at the time.

You then carry the exercise across the page, noting the changes made following a subsequent ‘restructure’ of the senior executive team in May 2006 (see Table 3). Only three of the seven appointments Mulcahy made in 2003 remained in the cadre of senior executives; a poor strike rate, to your mind. Though at least six of the seven executives in key roles in 2006 remained with the group in 2008.

Table 3: Suncorp CEO direct reports

2003		2006		2008
Role	Incumbent	Role	Incumbent	Role	Incumbent
Retail Banking	Mark Blucher	Business Banking	Stuart McDonald	Personal Insurance	Robert Belleville
Business Banking	Ray Reimer	Gen. insuran. Commercial	Mark Milliner	Vero NZ	Roger Bell
General Insurance	John Trowbridge	Gen. insuran. Personal	Mark Blucher	Commercial Insurance	Mark Milliner
Chief Financial Officer (CFO)	Chris Skilton	CFO	Chris Skilton	CFO	Chris Skilton
Projects, Services & HR	Peter Johnstone	Group Strategy	David Foster	Wealth Mgmt	Geoffrey Summerhayes (Dennis Fox)
Information Technology	Carmel Gray	People, Technology & Marketing	Diana Eilert	Information Technology	Jeff Smith
Wealth Mgmt, Strategy & Marketing	Bernadette Inglis (Fifield)	Retail Banking & Wealth Mgmt	Bernadette Inglis	Strategy, People & Corp. Services	Bernadette Inglis
				Integration	Mark Blucher
				Retail Banking	David Foster

Mark Blucher and Bernadette Inglis have been in key roles throughout Mulcahy’s tenure, so you comb through the annual reports to find their remuneration and make the appropriate calculations. You’re shocked and outraged by what you find – the remuneration of each executive has soared. You’ll be absolutely ropable if the board hasn’t reversed that trend in the 2009 financial year; particularly when it comes to the remuneration of newer appointment Stuart McDonald who’s overseen the problematic Business Banking area in recent years.

Table 4: Remuneration of key executives ($)

	2004	2005	2006	2007	2008	Growth rate (p.a.)
John Mulcahy	3,292,898	3,563,718	4,359,624	5,335,072	6,189,851	17.1%
Mark Blucher	1,281,870	1,178,144	1,306,639	2,236,645	2,038,004	12.3%
Bernadette Inglis	993,068	1,081,362	1,183,428	2,247,792	2,108,251	20.7%
Stuart McDonald	n/a	n/a	565,353	1,761,327	1,690,441	n/a

By this point your blood is boiling. It seems your directors have done a good job of allowing management to line its own pockets at your expense. And they also waved through the bet-the-company Promina acquisition at a price which looks horrendous (as the analysts at The Intelligent Investor declared at the time). You also note hefty growth in the fees of certain directors (see Table 5).

Table 5: Remuneration of long-standing directors ($)

	2004	2005	2006	2007	2008	Growth rate (p.a.)
William Bartlett	138,781	176,670	212,930	242,657	289,187	20.1%
Ian Blackburne	234,438	156,774	170,763	184,178	229,045	negative
Cherrell Hirst	181,168	137,137	163,240	198,240	251,037	8.5%
Martin Kriewaldt	138,781	142,238	152,293	161,928	209,152	10.8%
John Story	548,296	366,903	379,861	395,553	509,729	negative

‘That’s enough!’ you cry, exasperated. ‘This is just the kind of enraging situation that incited riots on the streets of London this year,’ you think. How could the board have allowed the remuneration of Mulcahy and his favoured executives to grow so excessively while shareholders have clearly suffered so much?

Table 6: Suncorp financial goals (2003)

1) Deliver returns to shareholders in the top quartile of the financial services sector

2) Produce annual productivity gains of between 5 percent and 10 percent

3) Consistently report a return on equity of more than 15 percent

Mulcahy failed to live up to even the company’s own standards. Following the 2003 ‘strategy review’, three clear criteria were set out in the annual report ‘to focus our efforts and measure our progress’ (see Table 6).

From your comparison of the share price performances of other banking and insurance stocks, it seems clear that Mulcahy failed on the first score. The second goal is difficult to measure, particularly in light of a large, company-changing takeover. But the third goal is easily measured:

Table 7: Return on equity calculations

	2004	2005	2006	2007	2008
NPAT ($m)	618	882	916	1,064	556
Beginning equity ($m)	3,640	3,992	4,514	4,433	12,390
Closing equity ($m)	3,992	4,514	4,433	12,390	12,360
Average equity ($m)	3,816	4,253	4,474	8,412	12,375
Return on average equity	16.2%	20.7%	20.5%	12.6%	4.5%

The return on equity for 2009 is likely to come in around 5% and you’re furious that Mulcahy could receive steadily rising compensation in the face of such poor performance against two clearly-defined and simple to measure goals. Particularly given one of the board’s key functions is to ‘Monitor financial performance and executive management performance in the implementation and achievement of strategic and business objectives’.

You also note that page 3 of the 2006 annual report (the year before the banking rot started to become apparent and the disastrous Promina deal was consummated) highlighted useful financial figures such as underlying profit (up 10.1% to $1,042m), earnings per share (up 3.9% to $1.67) and return on equity (21%).

Last year’s annual report contained no such highlights. And the more marketing-focused ‘Shareholder review 2007/08’ was even worse, highlighting a litany of random trivia such as: Top 25 Australian company (by market capitalisation), 81% employee engagement (in top quartile worldwide), 18,000 employees (including 2,000 in New Zealand), 35% of Australian households use our products and services and $94.2 billion (in) assets.

At the least, shareholders deserve consistent reporting. This kind of corporate spin is not only annoying but misleading. If clearly stated financial targets haven’t been met, then the company’s owners have a right to expect their directors will tell them about it.

New CEO appointed

You’ve also scrutinised the proposed remuneration deal for incoming CEO Patrick Snowball. Even before considering the financial rewards, though, you’re dismayed to note that none of Suncorp’s existing senior executives have been appropriately groomed for the role – not even Bernadette Inglis who must be amazingly impressive given her 20%-plus compound growth in remuneration.

Succession is a key responsibility of the board and Suncorp has now had to import two external CEOs in a row – hardly an indicator of the kind of management depth evident by internal appointments at the likes of Woolworths, or even the smaller Bendigo and Adelaide Bank.

Perhaps, you reflect, the board has learned a few lessons from the disasters of the past six and a half years. It seems clear to you that the balance between short term incentives and alignment with genuine long-term owners has been way out of kilter.

Poorer, but wiser?

Mulcahy was able to enjoy steadily rising remuneration even as the financial situation was deteriorating and shareholders were set up for a massive dividend cut (the latest interim dividend was down more than 60% on last year’s). So has the board wised up?

Upon examination of the particulars, you fear not. Snowball’s base pay – which has been given the misleading label ‘Total Employment Cost’ – is even higher than Mulcahy’s; he’s set to receive $2.1m per annum plus yearly return airfares to the UK for him and his family (and presumably they’re not going to be flying economy class).

In addition to his deceptively-branded Total Employment Cost (TEC), Snowball will be entitled to up to 150% of his TEC as a Short term incentive each year. That’s $5.25m plus, say, $50,000 each year in airfares. This strikes you as far too much to award based on just showing up (base pay) and short term incentives.

One of the clearest lessons from the current financial crisis has been the long-term damage that can be wrought by overly-generous short term incentives. The tragic end to John Mulcahy’s empire-building reign underlines this, yet Suncorp’s directors seem to have missed the memo.

For the record, Snowball’s long term incentive plan includes 900,000 rights to shares which will be awarded over the next three financial years, subject to certain hurdles. This equates to less than his potential annual compensation, so it’s clear where his focus will be.

That said, Suncorp’s board can be given a little credit for mandating that Snowball acquire, at his own expense, $500,000 worth of shares as soon as practicable after his appointment. The main negative here is, perhaps, a perverse incentive to talk the stock down prior to his official appointment on 1 September (along the lines of what Sol Trujillo was accused of doing at Telstra before the strike price of his options were set).

Action required

All things considered, you’re upset by the short term skew of Snowball’s package. If your directors haven’t learned from recent horrible experience, it’s safe to assume they never will. And if they’re not going to protect your precious capital, then there’s only one course of action left.

You resolve to go through the remaining board members one by one, determining who you think should exit stage left. Unless any of these individuals can prove – perhaps through the release of relevant board meeting minutes – that they took a stand against the Promina deal or voiced objections to Mulcahy’s remuneration, they should be voted out:

Table 8: Suncorp directors who deserve to go

John Story	As chairman, he oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal
William Bartlett	Director since July 2003, oversaw Mulcahy’s performance and remuneration; and the Promina deal
Ian Blackburne	Director since August 2000, oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal
Rodney Cormie	Director since December 1996, oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal
Cherrell Hirst	Director since February 2002, oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal
James Kennedy	Director since August 1997, oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal
Martin Kriewaldt	Director since December 1996, oversaw Mulcahy’s appointment, performance and remuneration; and the Promina deal

At this year’s annual meeting you’ll be taking appropriate action. Unfortunately, following the dilution in recent years, your 300m shares no longer give you total sway over the board. In fact, with 24.1% of the votes you’ll need to rally many other shareholders around you. Hopefully that won’t be a difficult task given the facts you’ve gathered paint a clear picture of poor performance. But Australia’s legion of small shareholders (and Suncorp has more than 200,000 of them) are notoriously apathetic; even in the face of terrible performance they’re likely to re-elect any director recommended by the chairman (who, in this case, should fall on his sword).

You begin to reflect on the entire unfortunate saga. As a capitalist at heart, it hurts when you find yourself concluding that this episode encapsulates all that’s been roundly criticised by capitalism’s opponents: Excessive director and executive compensation for poor performance, lack of accountability, shameful reporting and billions in shareholders’ wealth destroyed.

You struggle to think of clearer cases for shareholder activism in a large Australian company. When the notice of meeting arrives for this year’s AGM, you’ll be straight on the job – voting against the re-election of these people who have done such a poor job of defending your financial interests. Hopefully you won’t be the only one.

*The Intelligent Investor will be inviting Suncorp chairman John Story to respond to the criticism levelled in this article.

Greg Hoffman

What's this?

Back to top Back to Stock Reviews List

Sorry, your email address seems to be incorrect. Please check and try again.
You need to ensure that you have registered your details and your Internet Browser accepts cookies.