Income Report / Income Report: Revisiting Bank Valuations (ANZ, CBA, NAB, WBC)

By Market Matters 30 October 19

Income Report: Revisiting Bank Valuations (ANZ, CBA, NAB, WBC)

Market Matters Income Report 30th October 2019

The market has opened on the back foot this morning after a lacklustre session overseas, which we covered in more detail in the AM note today. Major developments since then include Costa Group (CGC) coming back online this morning, trading down however it is attracting some buying from the lows while Genworth (GMA) which sits in the MM Income Portfolio is trading up ~10% testing $4 on news they have renewed their contract with CBA to provide mortgage insurance. This is a good development given that CBA account for 53% of gross written premium in 1H19 - the deal lasts for another 3 years.

A volatile open for fruit and veg business Costa Group (CGC) which we hold in the MM Platinum Portfolio. The stock is trading at ~$2.70 at time of writing while the Rights are also now trading under code CGCR. At $2.70 the rights are worth 50c (2.70-2.20)  divided by 4 (1 for 4 entitlement) meaning that CGC shares are trading at $2.825 all things being equal (basis $2.70). Institutions took up 88% of their rights under the issue which is fairly strong with the remainder being put in an institutional bookbuild overnight which cleared at $2.30. CGC will continue to be a volatile beast particularly as the rights issue plays out. 27m shares are held short in CGC so some short covering would be expected from here given shorts are also now short the rights. Assuming the stock remains above $2.20, we intend to take up our rights, however we’re also looking to reduce our overall positon if strength should prevail in the short term towards $3 (simply from a risk perspective).  

In terms of economic data today, inflation was just out and it came smack inline with expectations

Overall, the ASX 200 is currently trading down -23pts or -0.35% to 6721.

ASX 200 Chart

The Income Portfolio was just about flat during the week, down -0.1% against the backdrop of the ASX200 Accumulation index which traded around ~1% higher. Recent portfolio leaders dragged this week with CSR (-4%) and GMA (-5%) giving back some of the recent gains. Rio Tinto (RIO) was the best holding in the 5 sessions, adding 3%. The portfolio is tracking above the benchmarks, currently up +2.67% financial year to date, versus its absolute return benchmark of +1.63%. Since inception the portfolio is up +19.63% vs the benchmark of +12.55%.

For those interested in investing for income in a low rate environment, Market Matters manages the investments for the Market Matters Active Income portfolio offered under Praemium SMA. The portfolio is based on the MM Income Portfolio. The SMA has now passed its first anniversary and performance has remained sound, the September update can be viewed - HERE

Revisiting bank valuations

The last income note we published specifically on bank valuations was in December of 2018 (click here) after the banks had had a terrible year. From a share price performance perspective, the big 4 were down somewhere between 14% - 22%, CBA the best of them while Westpac was the worst. From a P/E perspective the sector was on 10.9x and all 4 were trading at their cheapest (in terms of P/E & price to book) in more than 5 years. NAB for instance was on just 9.9x earnings trading at a price of $23.42 at the end of 2018.

Our conclusion to that report was: Clearly, the banks are cheap and are pricing in a significant amount of bad news. They obviously face further risks around large house price falls, more significant fines, penalties and customer remediation that occurred in FY18 and importantly a reduction in Australian economic growth which would produce an increase in bad debts, however it seems to us that share prices are currently factoring in these threats and the banks are susceptible to ‘less bad’ news. We hold the banks and believe they’ll reverse their underperformance in 2018, with outperformance in 2019, especially if the market remains volatile. As this stage, dividends are sustainable while capital returns through share-buys backs remain on the table. 

A couple of things became obvious from that statement. Performance has improved in 2019 and banks have done well this year, there has been more remediation, probably more than anyone had factored in however despite weakness in the economic picture locally, the concerns around housing and steep falls in property prices have not materialised, in fact after an orderly 10% correction in property prices they have bounced back well particularly in Sydney & Melbourne.  We also mused that dividends were sustainable at the time however since then, NAB joined ANZ in cutting their dividend

to a more sustainable level.

We now expect Westpac to be the next bank to cut their dividend marginally when they report on the 4th November, a slight reduction  down to 91-92cps from 94cps for the half.

In terms of the banks relative to one another, WBC now screens cheapest of the big 4 as the market prices in a likely dividend cut. It’s often the case that investors sell on rumour / buy on fact and this seems likely with Westpac. The obvious takeaway from the below is the big valuation premium by CBA trading on a +20% premium to the sector, Traditionally CBA holds a 12% premium to the others simply because it’s a better bank, better systems, better financial metrics and more capacity to grow earnings in a tough environment, however a 20% premium is rich.

Peer Group Comparison

Source: Bloomberg

Looking at this data another way, the below looks at historical ranges. WBC & ANZ (+BOQ for that matter) screen cheap while CBA & to a lesser degree NAB screen expensive.

Historical Premium Range – Banks v themselves

Source: Bloomberg

Also worth putting this data into context relative to the market and (as we highlighted this morning), relative to interest rates. The ASX 200 is trading on a P/E of 17.35x dropping to 16.82x in FY20 according to Bloomberg consensus while interest rates are at record lows. Historically banks trade at around a 20% discount to the market PE, today they’re trading around a 22% discount implying they’re still on the cheap side of history, however there’s also a valid argument that given their yields relative to the market and because of low interest rates, they should trade tighter than their historical discount– that’s certainly the view we hold by MM.  

ANZ Bank (ASX: ANZ) $27.93

We hold ANZ in the MM income portfolio and believe it represents solid value at current levels despite being slightly on the expensive side of history.

ANZ (ASX:ANZ) Chart

The recent P/E expansion from the December lows has ANZ slightly above fair value, however that doesn’t take into consideration the impact of low rates.

MM is bullish on ANZ

ANZ P/E Trends

Source: Bloomberg

Commonwealth Bank (ASX: CBA) $80.46

We do not hold CBA  in the MM Income Portfolio (although it resides in the Platinum Portfolio). We are technically bullish CBA targeting $85.

Commonwealth Bank (ASX:CBA) Chart

CBA has experienced a significant P/E re-rate back up since the most recent market sell-off, and now trades at a significant premium to the sector, and relative to its own history. While we believe CBA could squeeze up to $85, the risk / reward is not compelling.

MM  is neutral / marginally bullish CBA

CBA P/E Trends

Source: Bloomberg

National Australian Bank (ASX:NAB)  $29.11

We hold NAB in the MM income portfolio with the stock clearly enjoying a strong tailwind in recent times. A dividend cut and a new CEO has caused the market to look at NAB with fresh eyes. This has been a serial underperformer however 2019 has heralded a period of outperformance relative to the sector. NAB now trades at a price premium to WBC when history tells us  it usually trades at a discount.    

NAB (ASX: NAB) Chart

NAB is no longer the cheapest of the big 4, a mantle that it has often held. While we can see NAB being dragged higher by the sector, it is now on the ‘rich’ side of history

MM  is neutral / marginally bullish NAB

NAB P/E Trends

Source: Bloomberg

Westpac (ASX:WBC)  $24.53

We do not hold WBC  in the MM Income Portfolio (although it resides in the Platinum Portfolio). Last time we covered bank valuations we talked about WBC rarely being the best in its peer group and rarely the worst – it’s this stability that’s been at the cornerstone of WBC for decades. Well today, WBC is now the cheapest bank in the sector as a dividend cut looms large on the horizon, however as mentioned above, selling of rumour buying on fact can often play out in these sort of scenarios.

Westpac (ASX: WBC) Chart

Westpac is trading around about its average P/E however it’s around 6% cheap relative to peers.   

MM is bullish WBC

WBC P/E Trends

Source: Bloomberg

Conclusion(s)

We remain positive on banks overall, particularly for income

CBA & NAB are relatively expensive v WBC & ANZ

Have a great day!

James & the Market Matters Team

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.

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