-------------------------------------------------------------------------------- Valuations still looking attractive.
There remains fundamental positivity on the banks. Strong results supported 10% EPSg is on track. It is believed 13.7x 2003E earnings are attractive in the current environment.
The new target prices reflect 9% share price upside potential for the major banks plus a 4% dividend yield.
Sector performance is underpinned in the current muted environment, with reliable earnings growth and low risk driving expanded multiples.
The preferred picks are ANZ, CBA and SGB.
Earnings and Valuations
It is believed the Australian banks offer an attractive investment through a combination of strong returns, earnings growth and attractive valuations. The recent reporting season saw earnings forecasts remain intact with 9.1% EPS growth forecast for the sector in 2002, 10.5% for 2003 and 8.7% for 2004.
As the end of the financial year approaches rolled forward are the price targets to use 2003E earnings as the base year. The new price targets are ANZ $22.05, CBA $37.70, NAB $38.90, WBC $17.85 and SGB $22.03. The one year target prices imply an average 14x one year forward earnings in a year’s time. These target prices are predicated on a muted investment environment similar to today.
There is the current process of rolling out the fundamental valuations over the next few weeks. Not adjusted are the existing recommendations.
Whilst the Australian banks have performed very strongly in recent times, it is believed attractive returns are still available at 13.7x. The current muted environment is healthy for both bank earnings and prices relative to their peers. The banks also have less exposure to the negative earnings impact of a rising Australian dollar (given predominantly domestic exposures, ex NAB) and rising interest rates (as it is passed on to customers) than other investment alternatives.
The banks are now all ex dividend excluding SGB (38 cents, 12 June).
Held is a top down mild Underweight orientation to the Australian banks over the last six months based on macro expectations of a reversion to normalised global growth.
However, based on stock fundamentals, there continues to be seen underlying sector performance drivers that have a positive effect (earnings growth, returns, delivery and improved valuation dynamics).
The preferred stock picks are ANZ, CBA and SGB.
Improving value with growth delivery
As a result of reliable earnings growth, valuation stretch is now less of an issue, as PE's roll into 2003. Banks are currently trading at 13.7x 2003E earnings.
Rolled forward are the price targets to adjust for using 2003E as the base year. Currently there is the process of updating the composite fundamental valuation to take into account this base year change.
Now seen is a 9-10% share price upside to the banks and a 4% dividend yield, implying 14% total return on a 12 month basis.
Fundamental earnings story intact post results
The 1H2002 reporting season delivered net positive earnings surprises.
The FY2002 EPSg forecasts were intact at 9%, FY2003E (10.5%) and 2004E (8%). Earnings quality was reasonable.
Top line growth in banking division earnings streams could have been stronger. However, cost cutting helped offset near term pressure on the revenue and BDD lines. One-off tax rate cut helped earnings growth. Core earnings increased 4.2% sequentially, albeit assisted by cyclical margin gains.
Returns are strong, asset intensity is reducing
Banks continue to deliver and offer high single digit EPSg going forward. This combines with ROE’s in the high teens to deliver a healthy return on capital proposition to investors.
Return on assets continues to improve, as growth becomes less asset intensive and reliance on fee income increases. The banks are successfully migrating their business mix towards faster growing and less asset intensive earnings streams. Earnings volatility is also lower.
The last result saw ROA up 5bp to 1.18%, and ROE’s up from 0.4% to 18.3%.
Reducing risk inherent in returns
Two thirds of earnings are now generated from consumers. Of this total, close to a half is generated from deposit spreads, transmission businesses and wealth management. This means only half of consumer earnings are subject to lending risk, much of this underpinned by mortgage security.
In corporate and institutional banking, banks have successfully managed underlying lending risk via syndication. Reduced large single exposures have assisted success in the recent slowdown. Banks have broadly shared the burden in Pasminco-Ansett style blow-ups.
Dynamic provisioning appears to have also helped reduce BDD risk. The banks have now successfully delivered earnings growth in a domestic slowdown, assisting their sustainable PE multiple.
ANZ Price at posting:
0.0¢ Sentiment: None Disclosure: Not Held
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