Given the financial sector has about a 40% weighting on the ASX 200, it is clearly a sector we need to see growth from to achieve the end of year broker targets of 5550 (a composite of brokers targets, source - Dow Jones).
However since mid April, we have seen the financial sector pull back around 12% with a number of factors resulting in banking stocks being sold off aggressively in large volumes. Valuations as a result have come back to more ‘compelling’ levels. The big question remains though – will traders use this weakness as a buying opportunity?
Looking into their recent results
The banks have underperformed the ASX 200 by a considerable margin since mid April, coming off the back of what was actually a strong 1st half earnings season. Cash earnings at NAB, ANZ and Westpac were all extremely strong and showed positive growth. However NAB’s result showed headwinds were clearly evident in the second half of 2010. All banks delivered a positive surprise on bad debts. Analysts were concerned though that trading and fee income were weak, net interest margins could have been better, and their outlooks highlighted that costs and margins may struggle to improve dramatically. Revenues amongst these three banks were short of expectations and could have been the main driving force for the recent sell-off.
Regulations and its impact
Regulation is another uncertainly that has caused investors to ‘sell first and ask questions later’. There was some speculation that offshore funds were concerned the Labour government could look to impose a tax similar to what is being proposed for miners. Senator Fielding stoked speculation suggesting the banks have been ‘ripping off Aussies for years’, adding the Government should start taxation of the big four banks with their ‘obscene’ billion dollar profits.
In the Federal budget, the government announced a reduction in taxes on interest earned from bank deposits, which the big banks had long been arguing for. This could be beneficial for the banks. It could help to lower their overall funding costs as deposits become more attractive for investors, in turn giving the banks a more stable and domestic source of funding. Under the plan, individuals will receive a 50% tax break on earned interest up to $1000 on deposits held in banks, building societies and credit unions.
Looking at the big-four banks
Looking at the individual banks post sell-off and according to estimates by Goldman Sachs, the sector (as of 10th May) was back on full year 2011 price to earnings (P/E) multiples (ex dividend) of NAB 8.6x, ANZ 9.6x, WBC 10.6x and CBA the most expensive on 11.7x. What is interesting is that these valuations are not actually far off the levels of March 2009, when markets saw the explosion in price earnings expansion. However what is clearly different now, is that we are getting strong earnings–per-share growth from the banks plus bad debts have not only peaked but they are on the decline.
National Australia Bank Ltd: NAB is cheapest on its price to earnings and price to book perspective. It also interestingly offers the highest dividend yield of 7.6%. However sentiment is usually a bigger driver of prices and NAB’s shares are being held back by uncertainty over the proposed AXA takeover and its policies in potentially taking part in the UK banking consolidation.
Commonwealth Bank of Australia Ltd: CBA is the most expensive, but has the best quality loan book, an exceptional New Zealand franchise, and no real deposit migration headwinds.
Australia and New Zealand Banking Group Ltd: ANZ has solid revenue momentum, strong customer services and a smart Asian policy, which has the thumbs up from the market. It is also generating the highest net interest margins at 2.43% (7% higher than NAB, the second highest).
Westpac Banking Corporation: Westpac is clearly functioning well; generating 17.3% return on equities and has balance sheet momentum. It also seems to be performing well in New Zealand.
Sovereign debt issues
Most analysts would say the sovereign debt issues may have some impact on the banks’ funding costs. Deutsche recently highlighted this could have a bigger impact on CBA and Westpac. However it is worth remembering they are four of only a small number of banks which are rated AA in the world, so we should celebrate that. Importantly, whilst banks have been sold off to what to some see may be ‘compelling’ levels, sentiment recently has been quite negative and this may be the key driver for the banks. So it will be interesting to see if the negative sentiment abates and if value hunters come looking for what they may see as bargains. What we are seeing though is some increased volatility, so it will be interesting to see if traders sell into any real appreciation in share prices.
Take a share CFD position
Do you have a view on what the short to medium-term trends might be for our Australian banks?
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Updated: 12 May 2010
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