26 October 20
Subscribers questions (CCL, BUB, MP1, EHL, AZS, HLS, ASM, ARF, BLD, TYR, IGL, COPX US)
26 October 20
Subscribers questions (CCL, BUB, MP1, EHL, AZS, HLS, ASM, ARF, BLD, TYR, IGL, COPX US)
25 October 20
Market Matters Weekend Report – prepare for a move into Christmas
23 October 20
Big miners drag ASX into the weekend
23 October 20
Are the likes of REA Group & Carsales.com worth chasing? (MMM, OZL, CSL, JBH, REA, DHG, CAR)
22 October 20
Market recovers from lows, OZL prduction strong, Adore lists tomorrow @ midday (TPW, OZL, HLS)
22 October 20
Tapping into China’s impressive economic growth – who do we like? (MP1, Z1P, APT, ORE, WSA, FMG, A2M)
21 October 20
Stocks edge marginally higher, Energy leads, TPW & MP1 hit hard (TPW, MP1, PPS)
21 October 20
Income Note: Finding yield as rates continue to slide (BHP, CBA, SIQ)
21 October 20
Overseas Wednesday – International Equities & Global Macro Portfolio (APT, Z1P, XOM US, MSFT US, UBS US, QQQ US, DBA US)
20 October 20
Market drifts lower, Westpac does deal with Afterpay, BHP production inline (BHP, APT, Z1P, WZR)
The ASX has opened higher this morning thanks a strong rally in overseas markets following more ‘supportive commentary’ from the US Federal Reserve. Lower rates for longer is the general view this week from central banks. In today’s note we’ll look at bank valuations post the election induced rally.
Currently, the ASX 200 is trading +41pts or +0.66%, 6374
ASX 200 Chart
The Income Portfolio had a tougher week this week, slipping -0.79% as equity markets dragged. Whitehaven Coal (WHC) was the biggest detractor, falling 9% over the past 5 sessions although the stock is set to earn some back today following last night’s risk on attitude. The portfolio did receive dividends from CSR, MQGPD, MXT & NBI which helped support performance over the week. These dividends and the allocation to the less volatile income securities saw the portfolio do better than the share market which fell over 2% during the week.
Despite the slide, the portfolio is still well outperforming its benchmark, up 6.69% the financial year to date vs the benchmark of RBA +4% which is currently at 5.09%. Since inception the portfolio has added 11.39% vs the benchmark of 10.53%. This week saw MXT entitlement shares start trading taking our holding to 11.67%. The Neuberger Berman’s Global Corporate Income Trust (ASX:NBI) traded ex-entitlement in a 1-for-1 offer.
Bank valuations post rally
2019 to date has been a better year for the banks, and May in particular was a very strong month thanks to: 1. The election result 2. Tweaks to loan serviceability standards 3. The expectation of lower interest rates. The below table looks at the performances from the banks (including the regionals) calendar year to date.
2018 was a year when banks looked to bottom on numerous occasions but went onto make new lower lows on what felt like a continuous stream of bad news. While the recent rally from the lows has been encouraging, the obvious question is, does the move have legs?
Yesterday’s rate cut and the expectation of more to come is an overall positive for equity valuations across the board including banks, it’s certainly a positive for the property market however there is one main negative for the banking stocks that is worth considering. Banks margins have been under pressure and when interest rates fall, it’s harder for them to do anything about it. ANZ yesterday dropped rates by 0.18% and Westpac cut by 0.20% v the 0.25% cut from the RBA to help protect margins, while CBA, & NAB passed the cut on in full. If both CBA and NAB are to protect margins, they now need to recover the cut from depositors, which is ultimately bad news for savers.
Using CBA as a quick example, at last update they had $77B in transaction deposits paying an average interest rate of 0.76%, $180B in savings deposits paying an average rate of 1.14% and there were $221B in investment accounts (term deposits etc.) which paid an average rate of 2.53%. The combined funding from these sources was $478B (in 1H19) compared to home loans of $462B. It seems unlikely they can recover anything meaningful from the $77B sitting in transaction accounts with that impost likely to move onto those with investment accounts, while those with savings accounts paying an average of 1.14% will likely see their rate drop by the full amount. For CBA to protect margins it seems likely that most of the brunt will be felt by rates on investment deposits which would need to fall by 25 bps * (77+221)/221 = 33 bps. This appears achievable.
So, while yesterday’s rate cut is a positive for the market generally, it’s clearly a negative for savers and it could be a negative for bank margins if banks can’t re-price deposits. In theory, a 0.25% re-pricing across the deposit book seems achievable, however if the RBA cut again, the task becomes more difficult.
Turning to valuations, banks collectively now trade on 12.8x with 4 of 6 lenders in Australia still trading below historical multiples as shown below. CBA is now most expensive relative to the sector (+17%) but also relative to itself (+11%). Westpac & BOQ are 5% cheap while Bendigo is 8% expensive based on 5 year averages.
Peer Group Comparison
The last income note that looked at bank valuation was back in December 2018 (click here) and we concluded that 2019 would be a year of outperformance for the sector, and that’s certainly played out to date. At the time the sector was trading on 10.9x with NAB trading on just 9.9x. Looking above, the move higher in the sector has all been driven by P/E expansion rather than earnings expansion, or in other words, traders are getting more upbeat about the backdrop for bank earnings, however the analyst community hasn’t amended their thinking (yet). That’s typical with analysts’ generally following share prices at turning points.
One useful indicator for bank share prices is Auction Clearance Rates, which have started to tick up from a low base. The chart below tracks the banking index with auction clearance rates and the correlation is high.
ASX Bank Index (White) v Auction Clearance Rate (Orange)
ANZ Bank (ANZ) $28.05
While we don’t own ANZ across either portfolio, the move by the bank yesterday to withhold 7bp of the cut shows they are more focussed on protecting margins than bending to political pressure or targeting volume growth.
ANZ (ASX:ANZ) Chart
ANZ is around about fair value from a P/E perspective as shown below, however in an environment of low interest rates with an improving outlook for property, ANZ should remain well supported. Look for the next catalyst to come from earnings revisions rather than further P/E expansion.
We remain neutral / bullish ANZ for income
ANZ P/E Trends
Commonwealth Bank (ASX: CBA) $79.12
We have CBA in the Income Portfolio and we remain comfortable with the holding, even though it’s expensive. With their planned asset sales CBA should have tier 1 capital at 11.5% leaving room for some form of capital management.
Commonwealth Bank (ASX:CBA) Chart
CBA has experienced a big P/E re-rate back up and now trades at a premium to the sector, however it’s warranted in our view. Put simply it has better metrics relative to the other majors in terms of deposit funding & home loan distribution while it also has the best cost to income ratio. These metrics are supported by better IT infrastructure.
CBA P/E Trends
National Australian Bank (ASX:NAB) $26.58
As is the case with CBA, we have NAB in the Income Portfolio and we remain comfortable with the holding. NAB has been a big outperformer in recent weeks after their last result showed it was the bank with the strongest top line growth + it aggressively cut its dividend putting it on a more sustainable footing going forward. They also showed the lowest level of new impairments, the lowest level of total impairments, the lowest net write-offs, the lowest 90-day past due number while they are carrying the highest bad debt charge – all in all, asset quality is good relative to peers.
NAB (ASX: NAB) Chart
Similar to ANZ, NAB is around about fair value from a P/E perspective as shown below, however in an environment of low interest rates, they will likely remain supported.
We remain neutral / bullish NAB for income
NAB P/E Trends
Westpac (ASX:WBC) $27.54
WBC is rarely the best in its peer group and rarely the worst – it’s this stability that’s been at the cornerstone of WBC for decades.
Leading into the federal election, the short sellers targeted WBC given its exposure to residential property & high payout ratio. Those shorts have now aggressively covered as the below chart shows. Short interest had been steadily building since September 2018 peaking just before the election at 85m shares short. That number now sits at 57m implying that 28m shares have been bought to cover shorts.
Westpac (WBC) Shorts Chart
After basing out at $23.30 Westpac has rallied ~20% from the lows.
Westpac (ASX: WBC) Chart
WBC is actually on the cheap side relative to the sector and to its own 5 year average, however like the other banks, it will need earnings support rather than further P/E expansion to continue its rally.
We remain neutral / bullish WBC for income
WBC P/E Trends
Bendigo Bank (BEN) $11.20 & Bank of QLD (BOQ) $9.34
The regionals are interesting for the first time in many years as increasing compliance and regulatory costs in an environment of low growth has led to chatter about potential corporate activity to improve scale. Bendigo to date has been the big winner on speculation that a $10 billion merger with Bank of Queensland could be on the cards, however now that BEN has a market value of close to $5.5B after rallying +20% from the lows v Bank of QLD with a market value of $3.7B it would make more sense (in our opinion) that any scrip deal between the two would favour BOQ
Suncorp is also in the mix here with talk of a banking unit spin off. In our view, that would only make sense if Suncorp combined forces with another regional given without their insurance division their cost of capital would increase. Again, BOQ could make sense.
We hold BOQ in the Income Portfolio & remain bullish.
Bendigo Bank (BEN) Chart
Bank of QLD (BOQ) Chart
Have a great day!
James, Harry & the Market Matters Team
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