I don’t often disagree with my fellow Switzer Super Report expert, Charlie Aitken, but on the major banks I do. Despite being the most expensive bank, CBA remains my number one pick. The cheapest, NAB, which Charlie likes might be on a recovery path, however it is too early to call. Back on 19 May , I ranked the banks in the following order: 1. CBA, 2. Westpac, 3. ANZ and 4. NAB. While the differences are small, this is largely how they have performed over the last three months.
Importantly, no one should read too much into this – three months does not a summer make. However, with all major banks having reported (CBA with a full report, ANZ and NAB with a third quarter trading update, and Westpac with a capital update) it is timely to review and reconfirm the rankings.
There are four common themes emerging from the Bank reports, which are:
- revenue growth is slowing. CBA’s underlying income for the 2nd half year rose by only 3% compared to the 1st half year, for NAB, June quarter revenue decreased by 1% compared to the average of the December and March quarters, and while ANZ didn’t provide numbers, it said “revenue trends were a little softer”;
- the ability to take out expense is increasingly coming down to the Bank’s investment in technology. For some of the banks, particularly the Melbourne based banks, the easy wins have largely been had;
- cash NPAT growth going forward is more likely to be in the range of 6% to 8%, rather than 10% to 12% over the last couple of years; and
- there are absolutely no signs of any deterioration in customer arrears to suggest that a pick up in bad debts, which are currently at historic lows, is on the horizon.
What does this mean for bank shareholders? Bank shares may not witness huge gains if the market rallies – however there is also no risk of dividends being cut – in fact, moderate increases are more likely the go. So while cash rates remain low, enjoy the fully franked dividend yields – and contrary to most of the talk, there are not strong arguments to reduce weighting in this sector.
Why the CBA is the most expensive
Let’s get back to the CBA and why it is the most expensive bank.
The slide below (from CBA’s result pack) tells the story. It leads on ROE (Return on Equity) – and has done consistently on this metric for over a decade, has the highest capital ratio, and through the application of technology and productivity, has been growing cash NPAT at the fastest rate. It is also number one by market share in the key retail markets of home loans, retail deposits and credit cards.
Commonwealth Bank is very polite with its description of its peers – however, if you think alphabetically and translate Peer 1 to the bank starting with ‘A’, Peer 2 = ‘N’ and Peer 3 = ‘W’, you get the picture. And to be fair, the chart is comparing 30 June data for the CBA with 31 March data for the other three banks, however there hasn’t been that much change. ANZ has confirmed that its capital ratio (CET1) at 30 June was 8.3% (although it expects to get to 8.5% by 30 September), NAB was 8.46%, and WBC (due to the payment of its dividend) was at 8.3%.
And to make the point about relative strength, CBA has compared the size of capitalised software sitting on the balance sheets. CBA now immediately expenses any project expenditure under $10m – whereas the other banks often capitalise these amounts. Capitalised software has to be paid for – it is a reduction to ‘cash NPAT’ in coming years.
And the NAB?
The reason I don’t rate NAB higher has nothing to do with its troublesome UK banks. These are an irritant and in the scheme of things, relatively immaterial, and although NAB announced a further provision in its trading update of at least £75m, they will eventually get through this.
NAB’s problem is its core Australian banking business, where is has been the price leader, yet losing market share. In an oligopolistic market like Australian banking, trying to win market share through a price led strategy is pretty hard work. Giving away needless margin has meant that revenue growth has been negative – NAB has been going backwards.
Add to that a very troublesome technology upgrade programme, and a management team not up to the mark. Encouragingly, new CEO Andrew Thorburn wielded the axe on day one, and the 3rd quarter update pointed to a small uplift in home loan growth, although the business bank lost share.
NAB is a recovery story – however my guess is that it will take at least 12 to 18 months before you will see any hard data to confirm this, and those looking for an early re-rating by the market risk being disappointed.
The brokers are remarkably neutral about the major banks – with target prices very close to the current market price and sentiment in a tight range. ANZ is the marginal favourite with a sentiment rating of +0.1 (scale is -1.0 most negative to +1.0 most positive), with CBA the least regarded.
Commonwealth Bank is the most expensive on a forward multiple of 14.7, NAB is the cheapest at 12.3.
Source: FN Arena as at 22 August 2014. Sentiment scale (-1.0 to +1.0)
Commonwealth Bank’s premium of about 20% (FY 15 multiple of 14.7 is 20% higher than the NAB’s multiple of 12.3) is about middle of the range compared to recent trading norms, and it is hard to argue that it is not substantiated.
With NAB, there is upside – however there is also execution risk. Like the brokers, I don’t see that there is that much difference between the major banks at the moment. My ranking, with only a minor change in swapping NAB and the ANZ, remains:
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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