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Just how expensive are the banks? (FOR SOPHISTICATED INVESTORS ONLY)
By Craig Young Senior Research Analyst
Banks are expensive on all traditional
measures
National Australia Bank has been the strongest of the four
major banks, rising 46% (including dividends) for the calendar
year to 30 November 2013. ANZ and Westpac returned 34%
and Commonwealth Bank gained 31%. This compares with
the market’s1 rise of 19% over the same period.
The banks have become very expensive. Tyndall’s research
shows that the average price to earnings ratio (PE) of the four
major banks (whereby the earnings have been adjusted to
reflect long-term bad debt charges rather than current low
levels) is trading at around 33% above its long-term average
(as shown in Chart 1).
Chart 1: Adjusted PEs of the four major banks are at 2007
levels
x
20
Average PE of the four major Australian banks
(adjusted for long-term bad debt charges)
18
At the end of November 2013, the four major banks were
trading on an average adjusted PE of 14.5x, which is one
standard deviation above the long-term average of 10.9x. This
highlights the extreme variation of current valuations from
historical levels.
The last time the banks traded at these levels was before
the global financial crisis, after which the banks fell sharply
and required capital raisings. Banks are more likely to
underperform from current levels.
On a price to book (PB) valuation, Australian banks are among
the most expensive in the world, even when their high return
on equity (ROE) is considered. Chart 2 shows that the PB ratio
(which is the market’s value of a company compared to the
book value of its assets) for Australian banks is sitting above
the average of other global banks for their respective ROE (as
represented by the solid line).
For example, Commonwealth Bank (CBA), which is the most
expensive of the four major banks, has an ROE of 17% and a
PB of 2.7x, which is well above the 1.9x PB it should be trading
on. This means the market is paying more for CBA’s assets
than it should be - if taking into account its return on equity.
Chart 2: Australian banks’ price to book ratios are also
expensive
Global banks' price to book versus return on equity
3.0
EXPENSIVE
Westpac
2.0
14
ANZ
NAB
1.5
TorontoDominion Bank
Wells Fargo
1.0
CHEAP
Citi
Standard Chartered
Barclays
0.5
0.0
0%
16
CBA
2.5
P/B (x 1 year forward)
Australian banks
have been among
the strongest
performing stocks in
the Australian share
market this year.
Attractive dividend
yields have been a
primary driver of
the banking sector’s
outperformance in
this low interest rate
environment. With
valuations now very stretched, what lies ahead
for the banks, particularly when quantitative
easing in the US comes to an end?
Royal Bank
of Scotland
2%
4%
6%
HSBC
8%
10% 12%
ROE (1 year forward)
14%
16%
18%
20%
Source: UBS
12
Record headline profits, but weak
underlying results
10
8
6
4
2
Nov-86
Nov-87
Nov-88
Nov-89
Nov-90
Nov-91
Nov-92
Nov-93
Nov-94
Nov-95
Nov-96
Nov-97
Nov-98
Nov-99
Nov-00
Nov-01
Nov-02
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
Nov-09
Nov-10
Nov-11
Nov-12
Nov-13
0
Average adjusted PE of the four major banks
1 standard deviation below average
Source: Tyndall AM, Iress
Long-term average
1 standard deviation
above average
The recent bank reporting season showed record headline
profits for the banks and they delivered very pleasing
dividends to shareholders. When adjusting for very low bad
debt charges, the average profit growth (as measured by
earnings per share) for the four major banks was 1.8% pa in
the 2013 financial year. By comparison, profit growth for the
market (excluding banks and resources) is forecast to be 5.2%
pa2 for the same period.
S&P/ASX 200 Accumulation Index
1
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Just how expensive are the banks?
Tyndall expects this trend to continue with adjusted earnings
per share for the four major banks expected to grow on
average by 2.4% in the 2014 financial year. This compares with
IBES forecasts of around 8.2% for the market (excluding banks
and resources)2. This reflects a relatively weak credit growth
outlook – both in the household and business sectors.
Household debt remains elevated (with net debt at around
130% of income) compared with other developed countries
that have de-levered - and the Reserve Bank of Australia
won’t be keen to see this increase any further. Business credit
growth hasn’t rebounded as yet (currently running at a
seasonally adjusted annual rate of 1.0% pa versus the 10-year
average of 7.5% pa) and a recovery isn’t expected to occur
anytime soon.
Payout ratios unlikely to go higher
Banks have been able to increase dividends in recent years,
reflecting low credit growth and higher payout ratios.
Low credit growth created excess or ‘lazy’ capital for the
banks, which has been paid out as dividends. Banks have
subsequently increased their adjusted payout ratios to around
76% (as shown in Chart 3).
Banks should be able to maintain the current payout ratios,
but not increase them. We expect credit growth to increase
modestly from very low levels and banks need to maintain
more capital to satisfy Basel III requirements. Accordingly,
dividends should grow in line with earnings growth, as
opposed to in excess of earnings as has occurred in recent
years.
Chart 3: Bank payout ratios have peaked
Average payout ratio for the four major banks
(based on underlying earnings per share)
%
80
75
70
Forecast
65
60
55
50
45
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014(f)
2015(f)
2016(f)
40
Source: Tyndall AM, company reports (Westpac, Commonwealth Bank. National Australia Bank, ANZ)
Where to from here?
While bank dividend yields continue to remain relatively
attractive, particularly versus bond yields and cash, on a total
return basis, we expect banks to underperform. There is more
downside risk for the banks than upside risk in the near term.
Australian banks have been a major beneficiary of the low
interest rate environment, due to an unprecedented level
of monetary stimulus by global central banks. Once the US
Federal Reserve commences tapering its asset purchase
program, which is expected to occur early in the New Year,
long bond yields will rise and high-dividend yielding stocks,
such as banks, are likely to lose some of their appeal.
As mentioned above, expectations for a modest uptick in
credit growth will restrict the banks’ ability to further increase
their payout ratios and pay higher dividends.
If company earnings in the rest of the market outside of the
banks rise more than is currently priced in and we see a beta
(risk) rally, the banks may be used as a funding source to build
positions in higher risk assets.
Portfolio positioning
Tyndall, as an active manager, has been steadily reducing its
exposure to banks over the last 12 months and the flagship
Australian equity strategy (including the Tyndall Australian
Share Wholesale Portfolio) is currently underweight the
banking sector.
Underweight positions in Westpac and Commonwealth Bank,
which are the most expensive of the four majors, more than
offset overweight positions in National Australia Bank and
ANZ. While NAB and ANZ have outperformed the banking
sector for the year to date, they continue to have higher
expected returns than the other banks over three years.
Disclaimer
This document was prepared and issued by Tyndall Investment Management
Limited ABN 99 003 376 252 AFSL No: 237563 (TIML). The information contained in
this document is of a general nature only and does not constitute personal advice.
It is for the use of researchers, licensed financial advisers and their authorised
representatives. It does not take into account the objectives, financial situation or
needs of any individual. The Tyndall Australian Share Wholesale Portfolio (TASWP)
ARSN 090 089 562 is issued by Tyndall Asset Management Limited ABN 34 002
542 038 AFSL No: 229664 (TAML). Investors should consult a financial adviser and
the information contained in the current Product Disclosure Statement available
at www.tyndall.com.au before deciding to invest. Reference to individual stocks in
this material neither promise that the stocks will be incorporated into TASWP nor
constitute a recommendation to buy or sell. TIML and TAML are part of the Nikko
AM Group.
Source: IBES, Datastream and Citi Research
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Contact us
For information about Tyndall and our products and services, or to download a product disclosure statement, please call Tyndall Investor Services on
1800 251 589 or visit us online at www.tyndall.com.au. Alternatively please contact our retail sales team as listed below.
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Aaron Russell
National Sales Manager
Private Wealth
Telephone: 02 8072 6386
Mobile: 0403 473 327
Email: aaron.russell@tyndall.com.au
Jeremy Sherman
Regional Sales Manager Private Wealth
Telephone: 03 8672 9213
Mobile: 0437 773 688
Email: jeremy.sherman@tyndall.com.au
Luke Murnane Regional Sales Manager Private Wealth
Telephone: 07 3112 2764
Mobile: 0407 118 015 Email: luke.murnane@tyndall.com.au
Magda Dantas
Business Development Manager
Private Wealth
Telephone: 02 8072 6387
Mobile: 0448 111 592
Email: magda.dantas@tyndall.com.au
Andrew Julius
National Manager
Researcher Relationships
Telephone: 02 8072 6385
Mobile: 0413 482 492
Email: andrew.julius@tyndall.com.au
Issued: December 2013