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My view on ANZ

Paul Rickard
Thursday, November 01, 2018

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When describing ANZ’s full year profit result yesterday as “solid”, CEO Shayne Elliott made it clear that actions to simplify the business, reduce cost and rebalance capital had put the Bank in a good position to meet the challenges facing the industry. But with no revenue growth and a strained franking account position, the Bank will be relying on further share buybacks to maintain earnings per share and put a floor under the share price.

Fortunately, ANZ is in a very strong capital position due to the divestment of its Asian and wealth management businesses and organic capital generation. After completing its current on-market share buyback (it has around $1.1bn remaining from its original $3bn program) and already announced divestments, its capital ratio on September 30 (on pro-forma basis) was 11.83%. This is well in excess of APRA “unquestionably strong” target ratio of 10.5%.

Because franking credits are strained, “off-market” share buybacks are off the agenda. Also,  while the annual dividend of 160c per share (fully franked) is now secure, it won’t be going up. This leaves on-market share buybacks as the preferred method for returning capital.

ANZ will also “neutralise” its dividend re-investment plan (DRP), which means  buying on market an equivalent number of shares to that it issues  through the DRP. Along with share buybacks, this will support ANZ’s reported earnings per share.

Full year cash profit from continuing operations of $6.5bn was down 4.7% on the previous year, but $0.3bn better than analysts’ forecasts. It included “large and notable items” totalling almost $700m, of which $295 was for customer remediation costs arising from the Royal Commission and $206m for accelerated software amortisation.

Highlights included:

  • Strong performances in Institutional and in New Zealand. The former grew second half cash profit before provisions by 7% compared to the first half. In New Zealand, cash profit before provisions grew year on year by 7%. Interestingly, cash profit in   NZ has grown by almost 300% since 2010, and in 2018 , total expenses (in actual Kiwi dollars) were less than those incurred in 2010;
  • Bad debt provisions were at record lows. The Bank booked a cost of just $688m in FY18, down from $1,199m in the previous year. The second half loss rate was just 9bp. Importantly, the forward indicators are positive and show no signs of  mortgage or other financial stress;
  • Total expenses (excluding large and notable items) fell by 1.5%. Excluding Asian Retail, ANZ shed 2,710 positions, with Australian Retail losing 1,000 jobs (7%). ANZ said that most of these positions went in the second half, giving ANZ a trajectory for lower costs in the next half; and.
  • Tier 1 capital of 11.44% at 30 September (11.83% on a proforma basis).

Negatives included:

  • A weak result for the Australian Retail Bank, ANZ’s biggest division, where a slowing housing market and constraints on investor lending took their toll. Cash profit before provisions and excluding large and notable items for the second half was down 2% on the first half. Year on year, it rose by only 2%; 
  • Volumes were also weak – with year on year housing growth of 3% and deposit growth of 1% below system. The second half was even weaker, with housing growth slipping to 0.3% and deposits going marginally backwards. Shayne Elliott admitted that the tight control of expenses might have had some impact on volumes, implying that ANZ might have gone “too hard, too fast”; and
  • Net interest margin (NIM) declined from 193bp in the first half to 182bp. Some of this was due to customer remediation and other one off factors, while a change in the asset mix played its part as ANZ focussed on (lower margin) owner occupied home loans and customers switched out of higher margin interest only loans to lower margin principal and interest loans. On the flipside, ANZ’s recent increase to the variable mortgage rate was yet to fully flow through and looking ahead, the immediate outlook for NIM was more stable.

The brokers and the market

The market’s initial reaction to the result was positive, with the shares up 1.05% yesterday.  The analysts were on the whole a little more subdued. While noting it as a “beat”, UBS thought it was a little “messy”. Macquarie thought the result “credible”. Others were concerned about the deterioration in NIM and whether ongoing switching in the home loan market and regulator action on front book/back book pricing would put further pressure on revenue.

Overall, the major brokers remain reasonably positive about ANZ, with 5 buy recommendations and 3 neutral recommendations (no sell recommendations). The current consensus target price is $29.35, 13.2% higher than Wednesday’s closing price of $25.93. At this price, ANZ is yielding 6.17% (fully franked).

My view

Macquarie got it right in labelling it a “credible” result. I continue to believe that the major banks are “cheap” and ANZ’s result has done nothing to shake my confidence. While It is going to remain “revenue challenged”, the dividend is secure, capital position is strong and it is the most advanced of the major banks in simplifying its business and products to cut costs. Sentiment on the banking sector remains negative, so you can afford to be patient and buy on market dips.

Published: Thursday, November 01, 2018


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