Income Report / Income Report; Should we buy regional banks for yield? (BEN, BOQ)

By Market Matters 27 February 19

Income Report; Should we buy regional banks for yield? (BEN, BOQ)

Market Matters Income Report 27th February 2019

The market is trading higher in early trade – up around 18points at 10.37am, although there was some decent selling in the futures markets early on. Telstra (ASX:TLS) is trading ex-dividend today for 8c and is trading down 6.5c while we also saw the WBCPD which resides in the income portfolio trade ex-distribution for 79.56c. On the reporting front, Seek (ASX:SEK) has impressed beating 1H earnings expectations while importantly, they re-affirmed guidance for revenue growth in the range of 16-20% (the mkt was at +16.74%) while EBITDA will likely grow at 5% to 8% (the mkt was at +6.28%)  - the stock trading up ~8%. Janus Henderson (ASX:JHG) was also out with full year results which were a slight beat – the stock trading up +1.65% in early trade.  

ASX 200 Chart

The past week saw the Income Portfolio up by +1.05% thanks to a strong rally from Perpetual (ASX:PPT) which added over 12%, as well as some help from Alumina (ASX:AWC) which paid a healthy dividend, and Genworth (ASX:GMA) which put on over 5%. In the current financial year, the portfolio is up 3.21% vs the benchmark (RBA + 4%) which is tracking at 3.61%. Since inception (5/7/2017) the portfolio is up +9.94%, outperforming its benchmark (RBA Cash plus 4%) at +9.06%.

Should we buy regional banks for yield?

We’ve seen a wave a selling in the two regional banks since Bendigo released first half results on the 11th February - Bendigo Bank (ASX:BEN) has fallen from $11.15 pre-results to close yesterday at $9.83, a fall of nearly 12% while Bank of QLD (ASX:BOQ) initially fell in sympathy with BEN however the selling kicked up a notch when they downgraded guidance a few days later showing similar trends to their southern cousins. BOQ has now fallen from $10.66 the day before BEN reported, to close yesterday at $8.81, a drop of ~17%.  Over the same period, the sector generally has been fairly flat while CBA has more of less held its $2.00 per share dividend.

Bendigo Bank (ASX:BEN) Chart

Bank of QLD (ASX:BOQ) Chart

BEN goes ex-dividend in 2 days (1st March) for 35cps fully franked and it’s forecast to pay another 35cps in September, putting it on a yield of  7.12% fully franked, or 10.17% gross.

BOQ goes ex-dividend on the 24th April and should pay 38cps fully franked while its forecast to pay another 38cps in October, putting it on a yield of 8.62% fully franked, or 12.32% gross.

Firstly, were the results that bad and secondly, are these yields sustainable?

The results were poor and a subsequent share price sell off is justified, however it seems to MM that the SP slide in BOQ in particular has gone too far. The results themselves were weak, and they both showed a greater level of pressure on margins relative to the majors. Higher funding costs hurt regional banks more while loan growth was also tough to come by thanks to a soft housing market and increasing competition. In BOQ’s case, they also showed non-interest income was weak plus regulatory costs had gone up – seems to be a common trait throughout corporate Australia, not just the banks.

For both regionals, earnings expectations were cut fairly sharply - the market now expects BEN to generate earnings per share (EPS) of 82cps for the year putting them on a forward looking payout ratio of ~85%, while BOQ is also now forecast to generate EPS of 82cps and given market expectations of 76cps in dividends, the payout ratio is high at around ~92%.

To give some context here, NAB is forecast to generate EPS of $2.32 while paying out $1.98 in dividends putting it the same payout as BEN. The market for a while has been concerned about NAB’s ability to maintain its dividend, although I think that argument has lost some steam recently.

From the above, BEN’s dividend is stretched, but sustainable while BOQ has very little room to move on theirs which helps to explain the more aggressive SP decline of 17% since the 8th February – or in other words, the market is now thinking that a dividend cut is in the offing and we’ve already seen some analysts start to pencil in a cut in outer years.

We often talk about the elastic band stretching too far and while BOQ has challenges from an earnings perspective, the recent sell-off in our view has gone too far.

Bank of QLD versus ASX 200 banking sector

BOQ has now shown signs of support under $9.00, its cheap and although the payout ratio is stretched, the yield should be sustainable around current levels for the next 12 months. Bendigo has also fallen sharply, although we suspect they’ve held up relatively better given they pay a dividend in two days. While both are attractive from an income sense, BOQ has more negativity priced in.

We are adding BOQ to the MM Income Portfolio with a 5% weighting

Macquarie Hybrid – adding to the income portfolio with a 5% weighting

On Monday MQG announced a new tier 1 hybrid security which came as a surprise given they didn’t need to roll an existing note - we assume they saw the strong demand from NAB and tapped into it. While the deal opened on Monday, the broker bookbuild closed by Tuesday morning at 8.30am highlighting the high demand for the offer.

Here’s a quick recap of the note we sent out Monday. Security holders as at 22nd February will be able to subscribe.

Key points

1.       The rate will be set through the book build process with a range of 4.15% - 4.35% over the 90 day bank bill rate ( ~1.90%) –  however it will likely land at the lower end, assume 4.15%. This implies a rate of 6.05%.
2.       This is a typical tier 1 capital note, the same structure as the recent NAB deal however with two slight variances.
a) Macquarie has a lower franking component so the note has a higher cash element, which is good. Notes are franked at 45%.
b) Macquarie list 3 call dates instead of two. First call is 7.5 years, 2nd call is 8.5 years and 3rd is 9.5 years – which is typical of a Macquarie Note – in short, this gives them more headroom if they need it however, we’ve only ever seen them call on the first date (however never say never)
3.       The rate of 4.15% over is reasonable, although I don’t think they’re paying ‘overs’ in this instance. NAB at 4.00% v MQG at 4.15% highlights that NAB was a very good deal.
4.       The last security issued by Macquarie into the market was done at a 4.00% margin, and that was the MQGPC. It now has 5.8 years till first call date and is trading at a margin of ~3.71%  and a current capital price of $102.05

Ultimately, the new MQG note looks fair around current levels, and as per the recent NAB note, expect demand to be strong.

Perpetual – launching a new listed credit trust  

The MM Income Portfolio holds the listed MCP Master Income Trust, which invests in corporate loans – our original note on the trust can be found here – the holding has done well with a total return around ~11%.  Perpetual is planning to launch a similar sort of offer however they’ll be investing across the credit spectrum, not just in corporate loans. While we haven’t see the details of the deal as yet, we’ll do a piece on it when available.

Conclusion (s)

We are looking to buy Bank of QLD (ASX:BOQ) for income

We have added the recent NAB & MQG hybrids into the income portfolio

Watch for alerts

Have a great day!

James / Harry & 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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All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 27/02/2019

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