Big bank dividends can still grow

The Murray Report findings in relation to equity capital doesn’t mean the healthy dividends of the big four banks will shrink.

Summary: Big bank dividends can continue to grow, even if the Murray Report recommends that the banks hold more equity capital. The growth of the economy and management performance are the major threats to dividend growth.
Key take-out: Dividend growth can continue, and be just 1% slower than each bank’s profit growth, while significantly increasing the capital reserves.
Key beneficiaries: General investors. Category: Shares.

David Murray has proposed that Australia’s big banks be required to hold more equity capital. Murray’s interim report, published last week, suggested that the stability of Australia’s financial system would be improved if the ‘big four’ banks had more equity capital.

The report argues that more equity capital would reduce the chance that taxpayers would have to bail out the big banks if global events destabilised the Australian economy.

Does more capital = less dividend growth? No

In response to the global financial crisis (GFC) the four biggest banks (ANZ, Commonwealth Bank, National Australia Bank and Westpac) have used retained earnings and Dividend Reinvestment Plans (DRP) to significantly increase their equity capital since 2009.

Capital and dividends can continue to grow over the next five years if current business performance and capital management policies are maintained.

The growth of dividends and capital depends on bank profitability. Good profits will produce higher capital without affecting dividend growth. The performance of the Australian economy and bank management will have the biggest effect on each bank’s profitability.

CBA, with the highest return on equity, has the best record of growing dividends and capital. NAB produced the weakest growth in dividends and capital because it had the lowest return on capital.

Long-term dividend growth is likely to be about 1% per annum lower than profit growth. For example, if profits grew at 6% pa from 2014 to 2019, dividends per share could grow at 5% each year.

Actual growth over the next five years is uncertain, and is not likely to be the same for each bank. Analysis of a range of possible growth outcomes finds that current dividend policies would result in dividend growth being about 1% less than profit growth. Low profit growth is the major risk to increasing capital and dividends.

CBA is best positioned to achieve future capital requirements and maintaining dividend growth. NAB faces the greatest challenge to increase capital without reducing dividend growth.

Each bank’s performance since 2009 is summarised below, with possible dividend and capital outcomes for the next five years.

Commonwealth Bank (CBA)

CBA’s cash dividends grew 44% from $2.66 in 2008 to $3.83 in 2014, after falling to $2.28 in 2009. CBA increased its capital by 50% from $31 billion in 2009 to $46 billion in 2014. DRP provided 91% of the increase in issued capital. CBA issued new shares for seven of the last 10 DRPs.

Its payout ratio is about 75%, and 24% of dividends participate in the DRP. CBA’s return on equity (18.5%) is the highest of the four big banks.

Annual profit growth of 6%, payout ratio of 75% and DRP participation of 20% over the next five years could deliver:

  • Cash dividends of $5.21 per share in 2019 (36% increase);
  • Total dividends of $7.44 per share (includes franking credit of $2.23);
  • $23 billion increase in equity capital (up 50% to $69 billion). $14.5 billion from retained earnings and $8.5 billion from DRP;
  • Share price of $106.30 in 2019 (up 31%), if the shares sell at a gross yield of 7%. Current yield is 6.73%.

Westpac Bank (WBC)

Westpac’s cash dividends grew 25% from $1.42 in 2008 to $1.78 in 2014, after falling to $1.16 in 2009. Westpac’s capital increased by 36% from $34 billion in 2009 to $47 billion in 2014. DRP provided 83% of the increase in issued capital. WBC issued new shares for seven of the last 10 DRPs.

Its payout ratio is about 75% and 15% of dividends participate in the DRP. Westpac has the second-highest return on equity (15.6%).

Annual profit growth of 6%, payout ratio of 75% and DRP participation of 15% the next five years could deliver:

  • Cash dividends of $2.33 per share in 2019 (31% increase);
  • Total dividends of $3.33 per share (includes franking credit of $1.00);
  • $18 billion increase in equity capital (up 38% to $65 billion). $12.5 billion from retained earnings and $5.5 billion from DRP;
  • Share price of $44.40 in 2019 (up 31%), if the shares sell at a gross yield of 7.5%. Current yield is 7.5%.

ANZ Bank (ANZ)

ANZ Bank’s cash dividends grew 28% from $1.36 in 2008 to $1.74 in 2014, after falling to $1.02 in 2009. ANZ’s capital rose by 45% from $32 billion in 2009 to $47 billion in 2014. DRP provided 96% of the increase in issued capital. ANZ issued new shares for the 10 most recent DRPs.

Its payout ratio is about 70% and 15% of dividends participate in the DRP. ANZ’s return on equity is 15%.

Annual profit growth of 6%, payout ratio of 70% and DRP participation of 15% the next five years could deliver:

  • Cash dividends of $2.36 per share in 2019 (31% increase);
  • Total dividends of $3.37 per share (includes franking credit of $1.01);
  • $19 billion increase in equity capital (up 41% to $66 billion). $14 billion from retained earnings and $5 billion from DRP;
  • Share price of $44.95 in 2019 (up 34%), if the shares sell at a gross yield of 7.5%. Current yield is 7.44%.

National Australia Bank (NAB)

NAB’s cash dividends grew just 1% from $1.94 in 2008 to $1.96 in 2014, after falling to $1.46 in 2009, then taking five years to return to the 2008 level. NAB’s current capital of $47 billion is 26% higher than its 2009 level of $38 billion. DRP provided 68% of the increase in issued capital. NAB issued new shares for 9 of the last 10 DRPs.

Its payout ratio is about 80% with 15% of dividends participate in the DRP. NAB’s return on equity (13.3%) is the lowest of the big banks.

Annual profit growth of 6%, a payout ratio of 80% and DRP participation of 15% the next five years could deliver:

  • Cash dividend of $2.58 per share in 2019 (31% increase);
  • Total dividend of $3.68 per share (includes franking credit of $1.10);
  • $12.5 billion increase in equity capital (up 26% to $60 billion). $7.9 billion from retained earnings and $4.6 billion from DRP;
  • Share price of $44.70 in 2019 (up 31%), if the shares sell at a gross yield of 8.25%. Current yield is 8.19%.

This is an edited version of an article which first appeared in The Dividend Man, John King’s blog at thedividendman.blogspot.com.au. John King is a director of AJK Consulting.

The comments published are not financial product recommendations and may not represent the views of Eureka Report. To the extent that it contains general advice it has been prepared without taking into account your objectives, financial situation or needs. Before acting on it you should consider its appropriateness, having regard to your objectives, financial situation and needs.