Big four banks: be patient, but ready to ride out gyrations
The four big banks have stumbled a hefty 11 per cent over the past few weeks, Westpac setting the pace with a 15 per cent decline. Driving the selloff has been the departure of foreign investors who are petrified the Australian dollar is going to drop to US90¢ in a hurry.
While the Australian retail investor has been blamed for the overzealous buying of the high-yielding stocks, the real culprit since October has been the foreign funds desperate to buy yield. Foreign ownership of the Australian market is tracking about 10 per cent higher than the long-term average.
So with foreign money fleeing our shores, when will it be time to buy our banks? That is a difficult question because in global terms our big four, especially CBA and Westpac, are still extremely expensive.
Our four major banks are trading on fully franked perspective yields of between 5.5 per cent and 6.8 per cent following the recent selloff. With the possibility of another interest rate cut from the Reserve Bank, increasingly the chances of a spike in term deposit rates in the near term looks unlikely. Under this scenario it would be wise to simply buy any of the big banks when the yield gets to 6.5 per cent or better and ride out the gyrations caused by the fast-moving foreign funds.
CARDNO
At the end of 2012 we wrote about the dangers of investing in engineering group Cardno following a surprise downgrade to its earnings. The shares fell 21 per cent rapidly from $7.55 to $5.89 on the bad news. I was made to look silly when the stock bounced back to $7.30 within a few months, inspired by the company hitting the top end of its revised half-yearly earnings forecast.
But we should not ignore history. A few weeks back Cardno was forced to downgrade its full-year numbers by 10 per cent, causing another selloff. The stock is now trading at $5.35 a share, 28 per cent below where the price sat before the original downgrade late last year.
So where to from here? The stock's price-to-earnings (P/E) multiple has shrunk from about 13 times this year's earnings to just 10 times, making it look cheap. But we should hasten slowly. Cardno has spent the equivalent of its current market value on acquisitions since 2004 and in that time it has delivered no organic earnings growth.
Acquisition models tend to work when the company can keep buying businesses, seemingly adding to the bottom line. When the spending spree ends we invariably see the underlying businesses are treading water and not growing.
It is too early to put Cardno in this category, but until the company can generate decent organic growth it would be better to stand on the sidelines.
ALS
This week the highly successful mineral and industrial testing group ALS reported its earnings for the full year to March 31. Net profit came in at $238 million, the bottom of its guided range. The profit result inspired a rally of 16 per cent during the week.
Usually a result at the bottom of a range causes the share price to soften, but on this occasion the spate of downgrades in the mining services world had the investment community expecting the worst.
Most of the commentary about the result focused on earnings bottoming out in the year to March 2014, at which time the company would earn about $195 million and trade on a P/E of more than 15.
With strong industrial and environmental earnings and a bounce back in resources, the company could grow strongly again from 2015. ALS still generates about two-thirds of its earnings from commodities. With each passing day it would seem the spending on commodities has peaked. The problem with commodity booms and busts is historically the booms last about 15 to 20 years and the busts can be even longer.
If the Chinese-inspired boom is over, we could expect the mining sector to suffer for many years. For ALS it will be a matter of being able to generate enough revenue growth from its non-mining business. This would seem a hard task and it is easy to see the shares at about $8 before year's end.
matthewjkidman@gmail.com
Fairfax Media accepts no responsibility for stock tips.
Frequently Asked Questions about this Article…
The article says the big four banks have fallen about 11 per cent over recent weeks (Westpac down about 15 per cent). The selloff has been driven largely by departing foreign investors who fear the Australian dollar could fall quickly (the piece mentions concerns it could drop to about US90¢). There’s also a seasonal tendency for banks to underperform after the traditionally strong March–April period.
After the recent selloff the majors were trading on fully franked prospective yields of roughly between 5.5 per cent and 6.8 per cent. The article’s view is that those yields aren’t yet irresistibly high — it suggests waiting until yields reach about 6.5 per cent or better before buying, then riding out volatility caused by fast-moving foreign funds.
Foreign funds have been key drivers of recent moves: foreign ownership of the Australian market is around 10 per cent above its long‑term average, and withdrawals driven by fear of a sharp AUD fall have put pressure on bank shares. The article highlights that this kind of rapid foreign money movement can cause gyrations that domestic investors may need to ride out.
The article notes the possibility of another Reserve Bank rate cut and suggests that a near‑term spike in term deposit rates looks unlikely. Under that scenario, bank yields remaining around the mid‑single digits could be more attractive — but the piece still recommends targeting about a 6.5 per cent fully franked yield before buying.
Cardno surprised the market with a downgrade to earnings late last year that sent the shares down 21 per cent; although it briefly recovered, a more recent full‑year downgrade of about 10 per cent caused another selloff. The stock was trading around $5.35 and its P/E had fallen from roughly 13 to about 10. However, the article cautions that Cardno has spent the equivalent of its market value on acquisitions since 2004 without delivering organic earnings growth, so it recommends standing on the sidelines until the company can demonstrate decent organic growth.
The article explains acquisition‑led models can mask weak underlying performance: while buying businesses can boost reported earnings, once the acquisition spree ends the core businesses may not grow. Because Cardno’s historical growth has come from acquisitions rather than organic gains, that raises a risk that earnings could stall — a reason to be cautious until organic growth appears.
ALS reported a full‑year net profit of $238 million (the bottom of its guidance range), which prompted a 16 per cent rally in the share price because the market had feared worse. Commentary in the article points to earnings bottoming out in the year to March 2014 (forecast around $195 million, implying a P/E of more than 15). ALS still gets about two‑thirds of earnings from commodities, so its medium‑term outlook depends on whether resources spending rebounds and whether it can grow non‑mining revenues.
The article reminds readers that commodity booms historically run about 15–20 years and busts can be even longer. If the Chinese‑inspired commodities boom is over, the mining sector could suffer for many years. For ALS, that means investors should watch its ability to grow industrial and environmental (non‑mining) revenues; the piece suggests ALS could recover from 2015 if resources activity improves, but investors should be mindful of long commodity cycles.
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