May is interim reporting season for the major banks: half-year results for NAB, Westpac and ANZ, whose year ends in September, and a third-quarter “trading update” from CBA, which reports on the more usual June 30 full-year timing.
It is always a closely watched group of results, and this year was no different. And the banks came through with flying colours, with their best interim profit season yet. The combined half-year profits of the Big Four came in at a record $13.4 billion, up 7.2%.
Big Four’s profit machine rolls on
Analysts reckon that puts the Big Four on track for a combined full-year net profit haul of more than $25 billion.
This year, on the interim results, the Big Four’s return on equity averaged 16.1%, compared with 15.5% in the second half of 2012 and higher than most of their overseas peers – although matching the average of other major Australian companies.
In both 2011 and 2012, the Big Four Australian banks were ranked the most profitable in the world, according to the Bank for International Settlements (BIS). But to put the headline profits in context, they achieved this with pre-tax profits equal to 1.2% of their assets.
Not only have the banks been highly profitable, they have been a significant driver of the overall stock market performance.
CBA recently dethroned BHP Billiton as the biggest single component of the S&P/ASX200 index (although it is smaller in market capitalisation) and was responsible for almost 18% of the 644 points the index gained in the year to April 10, according to an attribution analysis published in the Brisbane Times. Westpac was almost as big a driver, and ANZ and NAB each generated just over 9% of the index’s gains – meaning that the Big Four banks were responsible for more than half of the index’s gain.
Search for yield ends in bank haven
This has been driven by strong overseas and domestic interest in the banks’ high-yielding dividends and earnings growth. In a low-interest-rate world, share investors cannot get enough of the alluring yields of the Big Four Australian banks.
The average dividend yield for the banks is running at almost one full percentage point – or almost one-quarter higher – than the average yield of the S&P500 index.
The yield is virtually the first thing investors want to look at. For example, ANZ reported a strong interim, with cash profit after tax surging by 10% to $3.2 billion (banking analysts prefer to focus on the cash earnings which excludes one-off items, discontinued operations and non-cash accounting items: cash earnings is used as the basis for calculating earnings per share, return on equity and dividends). But what really impressed the market was that the bank lifted its fully franked interim dividend by 11%, to 73 cents a share.
Westpac also came out with a strong interim result, lifting cash profit by 10% to $3.53 billion, but that was only an entrée to the four cent boost to the interim fully franked dividend, to 86 cents a share, augmented by a 10-cents-a-share special dividend, also fully franked.
In contrast, NAB could only lift its half-year dividend by three cents (3.3%) to 93 cents a share fully franked. Cash profit growth came in lower than this, at 3.1%.
There is no doubt that the Big Four Australian banks are outstanding businesses, being an oligopoly that dominates their home market, with an effective government guarantee behind them. They remain some of the highest-rated financial institutions in the world, at AA-. With comparatively low cost-to-income ratios, surplus capital and conservative loan provisions, the big Australian banks are cushioned to a significant extent from pressure on their earnings if the local economy enters a modest downturn.
They are certainly not identical: Westpac is the most domestically-focused of the four; ANZ earns 20% of its revenue from its Asian operations; NAB is still hamstrung by its troubled (but improving) UK businesses; while CBA has a powerful retail and business banking franchise, and dominates home lending with a 27.2% market share.
Bank shares still pay more than the banks themselves
But for most investors – particularly SMSFs – the main attraction of the banks is yield.
Market consensus forecast expects ANZ to pay a dividend of 167.4 cents a share in FY14. At a share price of $29.98, that places ANZ on a nominal yield of 5.58%.
An SMSF holding ANZ in accumulation phase is looking at an effective yield of 6.78% in FY14. If the ANZ shares are held in pension mode, the effective yield to the fund in FY14 is 8%.
For CBA, the consensus is looking for 365.9 cents a share in FY14. At a share price of $72.65, CBA is trading on a nominal yield of 5.04%.
Our SMSF in accumulation phase is thus earning an effective yield of 6.12% in FY14. In pension mode, the equivalent yield is 7.2%.
For NAB, the consensus dividend expectation for FY14 is 197.6 cents a share. At a share price of $33.07, the market has NAB on a FY14 yield of 5.97%. For an SMSF in accumulation phase, that equates to 7.26%, while for an SMSF in pension mode, the yield swells to 8.53%.
Lastly, Westpac is expected to pay a dividend of 186.3 cents a share in FY14, which prices the stock, at $31.67, on a yield of 5.88%. For an SMSF in accumulation phase, that is equivalent to 7.15%; in pension mode, the shares are effectively yielding 8.4%.
With five-year term deposit rates at the very same institutions running at 4.5 – 4.6% and 10-year government bonds trading at 3.3%, these are outstanding yields for the level of safety implied.
Valuations looking stretched – to some eyes
But there is one big problem – many in the market believe the Big Four banks are expensive for now, in an economy where credit growth in the medium term looks likely to be modest at best.
Investment bank UBS, for example, says the Big Four are in “bubble” territory, all trading at about 14.9 times earnings. UBS says ANZ and CBA are a sell, while it has a “neutral” rating on NAB and Westpac.
In contrast, Citi reckons the banks deserve to trade at a premium, and rates ANZ, CBA and Westpac as “buys.”
If it takes two different views to make a market, those two big global brokers certainly differ on the banks.
As for NAB, it is not exactly friendless: Deutsche Bank rates it a “buy,” Macquarie has it as “outperform” and JP Morgan recommends an “overweight” position. Switzer Super Report expert Paul Rickard also supports this view, mainly on a relative valuation basis compared to the other three banks.
There is the possibility of having your nice expected yield eroded somewhat by falling share prices if the bubble view does play out, but you can certainly make a case on yield grounds for buying the Big Four banks, with NAB’s higher yield reflecting the higher risk as it runs down its UK exposure.
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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