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Which banks are still a buy?

by James Dunn


To say that the big four banks had a belter of a year in 2012-13 is an understatement. Let’s just recap on the headline numbers:

ANZ – year ending September 30

  • Record cash profit, up 11% to $6.5 billion
  • Record net profit up 11% to $6.3 billion
  • Total dividend of 164 cents a share, up 13%

Westpac – year ending September 30

  • Record cash profit, up 8% to $7.1 billion
  • Record net profit, up 14% to a record $6.8 billion
  • Total dividend up 5% to 174 cents.

NAB – year ending September 30

  • Record cash profit, up 9% to $5.9 billion
  • Record net profit, up 33.6% to $5.45 billion
  • Total dividend up 5.5% to 190 cents.

CBA – year ending June 30

  • Record cash profit, up 10% to $7.8 billion,
  • Record net profit, up 8% to $7.68 billion,
  • Total dividend up 9% to 364 cents.

The total cash earnings of the big four banks for FY13 was $27.3 billion. Four years ago, coming out of the GFC, they earned $16.3 billion in total.

And CBA has raced out of the blocks in the current financial year, reporting last week a $2.1 billion cash profit for the September quarter, up 14% from the equivalent period last year, and potentially putting the bank on track for a profit of $8.3 billion to $8.4 billion this year.

Now there is talk of big US hedge funds lining up to short-sell the over-valued Australian banks; and also of CBA splitting its shares, on the grounds that a share price close to $80 is too large and off-putting.

Well, it's not too large or off-putting if you own them: especially if you have owned CBA shares since the float at $5.40 in September 1991, and have received a total of $38.67 in dividends along the way.

But $80 just might put you off buying CBA shares if you don’t already own them – and that goes for all of the big four banks, because they are virtually priced for perfection.

On the FNArena database, the broker analysts’ consensus target price for ANZ is $32.85 – it is trading just 14 cents below that.

At $79.10, CBA is actually trading 5% above the consensus target price of $75.05.

NAB, at $34.78, is 2.7% short of the consensus target price of $35.73; while Westpac, at $33.28, is also short of its consensus target price of $33.50.

The big four banks are still phenomenally strong generators of hefty fully franked yields, which make them the cornerstone holdings of many self-managed super fund (SMSF) portfolios.

On consensus estimates, the big four are expected to return the following over the next 24 months:

Consensus estimated yields



But, as always, these nominal yields have to be placed in the context of how the franking credit rebates to an SMSF augment these yields, firstly if the shares are held in a fund in accumulation phase, and secondly for a fund in pension phase.

To an SMSF in accumulation mode, ANZ is priced to offer an FY14 yield of 6.32%, rising to 6.8% in FY15; CBA should yield 5.95% in FY14, and 6.07% in FY15; NAB is projected to pay 7.05% in FY14, and 7.53% in FY15; and Westpac looks like offering 6.92% in FY14 and FY15.

If the fund that holds the shares is paying a pension, ANZ is priced to offer an FY14 yield of 7.43%, rising to 8% in FY15; CBA should yield 7% in FY14, and 7.14% in FY15; NAB is projected to pay 8.28% in FY14, and 8.86% in FY15; and Westpac is effectively offering 8.14% in FY14 and FY15.

Of course, many of the shareholders will do substantially better than these yields, because they bought the shares at lower prices. For example, had your fund bought CBA five years ago, at $32.10, the FY15 projected yield would be a nominal yield of 12.4% – rising to 15.05% for a fund in accumulation phase, and 17.7% for a fund in pension phase.

Or had your fund bought ANZ five years ago, at $13.78, the FY15 projected yield would be a nominal yield of 13.3% – rising to 16.2% for a fund in accumulation phase, and 19% for a fund in pension phase.

You can see why many SMSFs are very reluctant to part with their bank shares.

The FY13 results were assisted by lower-than-expected charges for bad and doubtful debts (B&DD), which more than offset weakness in revenue and costs.

But analysts say it is difficult to see the banks’ profitability – as measured by return on tangible equity (ROTE) – expanding from current levels. The outlook for ROTE is at best flat, which influenced Goldman Sachs to estimate that bank forward earnings needed to be about 10% higher to justify the sector’s current price-to-net tangible assets (NTA) multiple versus industrials.

Of course, while they face common issues of net interest margin pressure, interest rate risk, market risk, operational risk, funding risk and potential regulatory change, the big four are different beasts, and can’t be viewed the same. The differentiation is marked by ANZ’s Asian expansion strategy; CBA’s greater exposure than the others to stock market moves, through its proportionally larger funds management/wealth arm; NAB’s UK presence, which it has not fully exited, and its ongoing core banking system replacement, which carries significant execution risk; and Westpac’s greater reliance than its peers on wholesale funding, because it lags in deposits.

Broker Citi, for example, rates the banks in order of preference as CBA, WBC, ANZ, and NAB – with preferences following profitability. CBA ranked top dog because of its strong deposit franchise and higher returns, but Westpac is narrowing the gap with CBA on funding and asset quality. With credit growth strengthening, term funding costs falling, and stability in housing and small-to-medium enterprise (SME) loan margins, Citi expects mid-single digit earnings-per-share (EPS) growth in FY14, with banks still “in a very sweet spot in the cycle.”

For its part, Goldman Sachs says the sector’s valuations are ignoring a “deteriorating trajectory” in profits (before provisions). Goldman Sachs would only buy NAB, saying that over the next two years it forecasts NAB to deliver the best EPS growth of the group, and to be the only major bank to increase its ROTE. Goldman Sachs is neutral on ANZ, but says it’s time to sell CBA and Westpac.

Baillieu Holst last week gave its clients the “top 10 reasons to take some profit in banks.”

  1. Valuations are stretched;
  2. Upgrades were priced in before the result;
  3. Great run since May after bank sector pull-back;
  4. Currency higher than most analysts expected;
  5. US tapering worries are back with latest strong growth data;
  6. Three of the big banks go ex-dividend early in November;
  7. Majority of the investor universe has been ‘long’ the banks for a while;
  8. Brokers have mostly moved to ‘hold’ recommendations with limited upside;
  9. IPO line up pre-Christmas needs funding vehicle; and
  10. US Hedge funds are looking at Australian banks, like in May.


Remember, though, that these views are not meant to be that of the SMSF investor, holding the bank stocks for yield. Whether the bank share prices have gone into over-valued territory is not necessarily an argument that concerns SMSF investors: to them, the dividend flows and the yields those represent are always the most important numbers.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Published on: Monday, November 18, 2013

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