Don't bank on huge earnings growth

The “big four” banks may be hard pressed to replicate last year’s performances, despite what recent credit growth figures suggest, according to major investment firms.

Australia’s leading bank analysts say ANZ, Westpac, Commonwealth Bank and National Australia bank won’t be able to grow their earnings as much this financial year, though dividend yields are unlikely to come under pressure during the period.

Market consensus is for cash earnings growth across the big four to fall to 5.8% on average in 2013-14, from 9.6% last financial year, but for dividend yields to lift by 50 basis points to 5.9%.

Investment firms’ updates on the sector follow the release of credit growth statistics by the Australian Prudential Regulatory Authority last Friday. The figures showed overall lending balances rose 0.5% in December – the ninth consecutive month of year-on-year increases – taking total credit growth in 2013 to 3.9%.

At face value the results were impressive. Housing credit – which makes up around 60% of the credit market – appears to be recovering with a 0.6% lift, and business credit (the next biggest segment) showed signs of life with its increase of 0.4%.

But banking analysts at UBS, CIMB Securities, Morgan Stanley and Credit Suisse argue that the housing credit growth is structurally weak and short-lived as it is being driven by investors, not-owner-occupiers. Investment loans increased 9.9% in the last quarter of 2013, almost double the 5.3% growth of owner-occupied loans. As shown in the graph below, only NAB had more owner-occupier home buyers than investors out of the major banks.

Meanwhile, the pick-up in business lending is only gradual and from a low base, one leading analyst says. The analyst forecasts flat net interest margins in 2014 as improved asset quality and lower funding and deposit costs are offset by more competition in the mortgage and institutional spaces.

As Justin Braitling revealed in Three weak spots in the big four, in this earnings environment the banks are having to tightly control their costs and even resort to aggressive accounting practices to meet investor expectations.

However, the banks won’t need to reduce their payout ratios given the number of capital initiatives each of them may implement, says JP Morgan. The broker notes the capital inflows expected for each of the banks during 2014, with ANZ selling its minority interests in Asia, NAB offloading its UK division, CBA completing its property sale and Westpac capitalising on its efficiency in wealth operations.

With dividends remaining stable, Credit Suisse asserts that bank shares won’t lose ground. After research into the staggering influence of self-managed super funds on the market last week, the broker removed its “underperform” rating on Westpac. It told its clients to pay more attention to dividend yields and dividend growth, and less to price-earnings multiples and earnings per share growth in their equity market strategies.

But the bottom line is that given the banks’ exceptional share price gains over the past two years and their benign earnings outlook this year, investors may not be able to blindly pick a bank out of the big four and expect 30% returns.

ANZ Banking Group

Where the leading analysts reach the most agreement among the big four is with ANZ. UBS, CIMB Securities, Deutsche Bank and Credit Suisse each select ANZ as their favourite bank for 2013-14 due to the company’s growth advantages. They rate ANZ as a buy, with the exception of UBS which has it at neutral.

John Abernethy of Clime Asset Management, and a regular Eureka Report contributor, has already made the switch from CBA to ANZ. He says there are limited opportunities in the Australian financials market after the run-up, and investors need to seek out companies with offshore exposure.

As the only Australian bank to have built a major presence in Asia, ANZ is leveraged to one of the fastest-growing emerging market regions in the world. The bank aims to generate between 25-30% of its revenue from the region by 2017 (up from 20% in 2012-13) by organic growth and targeted expansions.

But it’s not just ANZ’s momentum from overseas that has brokers positive on the stock. The bank is stealing market share from its rivals in total lending, as shown in the credit growth rates below.

Click to enlarge

Credit Suisse also likes ANZ because of its relatively strong debt capital markets franchise compared to the other banks. It believes one of the outcomes of the financial system inquiry into the banks to be conducted this year, which will be headed by former Commonwealth Bank CEO and Future Fund chairman David Murray, could be the development of a corporate bond market in Australia – where ANZ is best leveraged to benefit.

Credit Suisse has an “outperform” recommendation on the stock, with a price target of $35.80.

National Australia Bank

NAB ranks as the second preferred bank for many of the big brokers, even after the stock’s 39.3% surge in 2013 amid the improving outlook for Europe.

In an environment of challenged earnings growth, NAB is best placed to enhance its return on equity (ROE) as commercial real-estate in the UK improves and through the potential sale of long-term laggard Clydesdale Bank, says Credit Suisse.

Like with ANZ, Credit Suisse has a buy recommendation on NAB, but it says the ROE expansion for the stock is riskier and won’t be realised as fast.

After NAB’s performance last year, the stock also trades at less of a discount to its peers. It has a current price-earnings ratio of 14 times, roughly in line with Westpac and above ANZ.

JP Morgan isn’t as optimistic about NAB and has a neutral rating on the stock. Though its latest report on Wednesday headlines with “What was unsellable last year is now hot property”, it says rising interest rates still present a risk to property valuations and that timing will be everything to get the most value out of its UK property exit.

The bank also may have to hold onto the sale proceeds – and not deliver it to shareholders – as part of the new Basel III tier one capital requirements under the D-SIFI (domestic systemically important financial institution) framework.

Westpac

Several investment houses improved their earnings forecasts for Westpac after the bank completed its Lloyds Australia acquisition without equity funding at the start of the year, but the vast majority still say the bank is a hold.

In an update to the market in mid-January, Deutsche Bank said it didn’t see the transaction as transformational as it was only marginally accretive and the bank had paid away most of the synergy value.

“Coupled with a sub-peer earnings growth forecast over the next two years and a 12-month price-earnings ratio in line with historical averages versus peers, we retain our hold rating,” the broker said.

However, other analysts see improvements. Despite believing the sector to be overpriced, Goldman Sachs upgraded Westpac to neutral from sell last month as lower costs from term deposits translate into higher margins for the bank. CIMB Securities also upgraded the stock to neutral in December.

What Westpac also has going for it is likelihood it will deliver further special dividends given its capital position and improving revenues, according Macquarie. Westpac grew its revenue by 3.2% in the second half of 2012-13 – its biggest increase since the GFC – after making big investments earlier in the year.

Macquarie is by far the most bullish on Westpac, with a buy recommendation and a price target of $37.76 on the stock.

CBA

Analysts anticipate another record profit from CBA when it delivers its half-year results on Wednesday next week, with the average cash earnings forecast to hit $4.1 billion – 8.5% above the previous corresponding period.

The interim dividend is also expected to climb, this time 9.8% to $1.80 per share.

Given the market has already factored in an impressive amount of growth for Australia’s biggest bank, most analysts say the stock is either a hold or sell at current share price levels.

Indeed, CBA is currently the worst-rated bank out of the six-member S&P/ASX 200 Banks index amongst broker recommendations, according to Bloomberg. Just today, Bank of America Merrill Lynch downgraded CBA to underperform from neutral, calling the company the most overvalued of its peers.

CitiGroup also pointed to the company’s full valuation when it downgraded CBA to neutral from buy in mid-January. After running up the most since September 2011 lows, CBA is priced at an earnings multiple of 15.2 times, while the average of the other three banks is 13.4 times.

The bank’s retail business will also face increased pressure in 2013-14, says Macquarie. Like CitiGroup, Macquarie has a neutral rating on CBA. It believes though some upside remains in the credit card market after CBA increased the number of products per customer, retail margins (that are at five-year highs) look unsustainable due to increased competition.

* This article is part of the “It's Time” series in Eureka Report focussing on new opportunities for investors in 2014. Click here to see the entire series.