Most Bankable Banks

ANZ's John McFarlane and Bank of Queensland's David Liddy may be the getting all the plaudits in the banking industry at present but investors looking to make money from fully priced bank stocks in the coming months should take a second look David Morgan at Westpac and Gail Kelly at St George.

New research indicates Westpac will outshine its arch-rival ANZ in the coming months as the Westpac share price rafts up to match the average price target set for it by 10 leading stockbroking companies that participated in a survey carried out for Eureka Report by FN Arena.

In a fully priced banking sector, where every tiny detail of banking activity is closely monitored by stock researchers, Westpac is set to rise by almost 10% before it reaches an average price target of $25.07.

Gail Kelly, the managing director at regional powerhouse St George, is the banker set to offer the biggest rewards for investors in second-line bank stocks. With all three rivals '” Adelaide Bank, BoQ and Bendigo expected to flatten or decline in the near term, St George is the only regional bank whose price targets are higher than current prices.

As the resources-laden ASX gets increasingly volatile, investors are looking again towards bank stocks to provide stable returns. Well-run, well-regarded and offering fully franked dividends, bank stocks represent the backbone of many share portfolios. But in mid-2006 the biggest challenge to new investors in the banking sector will be avoiding short-term losers. In short, it's the art of judging which bank chief executive will fail to match market expectations?

The table below shows how investors have yet to be convinced that former airlines boss Ralph Norris will make the grade at Commonwealth Bank, while the former Barclays UK executive John Stewart is also facing a sceptical investing public three years after taking the top job at NAB. Among regional banks, the toughest questions surround the future of Bendigo Bank and its chief executive Rob Hunt.

Reading the table from the left, the outstanding signal from the new research is that the market has not yet put its faith in the Commonwealth’s new chief executive, Ralph Norris. It's worth bearing in mind there would be long periods when there are no “sell” notes at all to be found among the banks '” there are three sell notes in the market against CBA.

Norris has a hard act to follow. David Murray ran the Commonwealth for 16 years and history would suggest major banks can be riddled with difficult challenges in the wake of a successful CEO's departure. Just ask Frank Cicutto, who took over at NAB after a stellar run from Don Argus '” NAB later spiralled into a crisis that culminated in Cicutto's resignation.

According to FN Arena' s Rudi Filapek-Vandyck: "It's obvious the market is not yet supporting Ralph Norris at CBA. The table also suggests the duo of John Stewart and his Australian chief executive, Ahmed Fahour, brought in to resurrect NAB from the Cicutto era, are also facing problems.

"At first glance it would look like there is not much difference between the figures on ANZ and NAB, but you must remember ANZ stock has been exceptional for years. NAB, on the other hand, is the stock that investors have struggled with and where they are still waiting for the turnaround," says Filapek-Vandyck.

Inside the banking industry '” including inside the Reserve Bank '” ANZ chief executive John McFarlane is generally regarded as the top banker among the big four. McFarlane has surpassed David Morgan (himself a former Reserve Bank official) to take the mantle of Australia's master banker.

Over the course of a decade, McFarlane has managed banking toughest double act '” keeping shareholders happy while gaining unfailing respect from the regulators, especially the RBA. With a return on equity figure of 20% and a cost to income ratio of 45.8 (the lowest in the banking sector) McFarlane is hard to beat.

However, investors look to the future and Westpac's leverage to a revival in the NSW economy is seen as an underestimated positive for the stock. Westpac’s stock price has fallen from a peak of almost $26 in May to $22.17 today.

m '¦ and how markets rate the banks
	Price	P/E	Cash earnings ($m)		Cash EPS (¢/share)		Dividend (¢/share)		Cash ROE (annualised %)		Cost to income (%)
			1H05	1H06	1H05	1H06	1H05	1H06	1H05	1H06	1H05	1H06
Adelaide Bank	$13.20	16.9	33.4	41.4	35.5	40.2	24	26	17.2	16.1	55.4	54.6
(change %)				23.8		13.4		8.3		- 5.9		- 1.5
ANZ	$26.70	14.8	1,568	1,713	85.7	94	51	56	19	20	46.8	45.8
(change %)				10.4		9.7		9.8		5.3		- 2.1
Bendigo Bank	$13.13	19.1	41	48.3	29.3	34.6	19	22	12.2	13.5	69.6	68.3
(change %)				17.8		18.1		15.8		11.1		- 1.9
Bank of Queensland	$14.71	16.3	32.3	37.5	32.5	35.5	23	27	12.8	12.9	65.7	64.1
(change %)				16.1		9.2		17.4		0.8		- 2.4
Commonwealth	$45.20	14.2	1,733	2,061	132.1	149.5	85	94	19	21.7	50.2	48.1
(change %)				18.9		13.2		10.6		14.2		- 4.2
NAB	$35.78	16.7	1,652	1,840	106.2	115.5	83	83	16	17.4	58.6	55.6
(change %)				11.4		8.8		0		8.7		- 5.1
St George Bank	$29.72	16.9	444	495	86.8	94.6	67	74	21.8	23	45.4	44.1
(change %)				11.5		9		10.4		5.5		- 2.9
Westpac	$22.53	14.4	1,344	1,511	73.2	81.9	49	56	22	23	49.8	46.8
(change %)				12.4		11.9		14.3		4.5		- 6.0

Compared to the resources sector, the banking sector is relatively easy sector to analyse; after all, there are just eight listed retail banks '” four majors (ANZ, CBA, NAB and Westpac) and four “juniors” (Adelaide Bank, Bendigo, Bank of Queensland and St George).

Among regional banks, long-distance tenure is the order of the day. Two leading CEOs have been in the top job since the 1980s '” Adelaide Bank's Barry Fitzpatrick for 21 years and Bendigo Bank's Rob Hunt for 17 years. (To see today's video interview with Rob Hunt click here). At St George, the biggest of the regional banks, chief executive Gail Kelly has built a sterling reputation managing a mid-sized bank, while David Liddy at Bank of Queensland (BOQ) has been so highly rated that stockbrokers at Merrill Lynch earlier this year were prompted to call BOQ “the most expensive bank in the world”.

Among the regional banks, Liddy's ability to grow market share for Bank of Queensland has impressed a range of institutional and private investors (one of the bank's best-known private investors is the transport tycoon Lindsay Fox). Liddy has succeeded in his home market of Queensland by taking his larger rival Suncorp Metway in the Brisbane and Gold Coast market.

But as the FN Arena figures, show St George’s Kelly is most likely to be the chief beneficiary of changing sentiment in the banking market over the coming months. St George shares hit a peak of $30.50 in early May, and have since slipped to $29.42 today.

On the other hand, the figures do not bode well for Bendigo Bank’s Rob Hunt. The Victorian regional bank looks as though it is heading for a near-term share price fall with average price targets significantly lower than the current price. As Hunt tells Eureka Report in today's video interview: "Whether it be community banking or our traditional branches, our existing shareholders (have) a good deal of comfort that we can manage to keep the momentum going while there’s still strong demand for the business around the country."

However, it is hardly a coincidence that the bank that performs worst on the FN Arena sentiment indicator '” Bendigo Bank at –0.5 '” is next bank in line for a change of chief executive.

Hunt recently had the terms of his employment changed to a year-by-year contract, a common signal that tenure is coming to an end. Hunt told Eureka Report he believes a lengthy tenure for the CEO is important when any bank is bedding down a long-term strategy; however he readily concedes there is sufficient talent in the ranks at the bank to replace him.

Bendigo Bank also faces the exceptional challenge of extending the customer and community focused model that Hunt built since he transformed the enterprise from the unlisted Bendigo Building Society of a decade ago.

As Carlos Castillo, a senior analyst at CommSec suggests: "The issue across the banking sector '” whether you're talking about majors or regionals '” is downside risk; most of the banks are fully priced."