My old mate Charlie Aitken has had to go on a short sabbatical for a couple of weeks, so this week I want to share with you what Paul Rickard thought about the ANZ result.
This comes when NAB positively surprised the market on Thursday and many of us are holding our breath to see how the Royal Commission recommendations and Government response affects the bottom lines of the banks. Both Paul and I believe the market has taken the logical pathway of dealing with uncertainty the way it always does — sell first and ask questions later.
However, as longer-term investors we believe that when it comes to the banks, we’re in, or around, buying territory. What follows is Paul’s take on ANZ’s show-and-tell on Wednesday, which he wrote for Switzer Daily , but the difference is that I’ve decided to throw my twopence in as well, which I will slip henceforth into brackets, so Paul can’t complain that my view has tampered with his!
(He can be like that!)
When describing ANZ’s full year profit result yesterday as “solid”, CEO Shayne Elliott made it clear that actions to simplify the business, reduce cost and rebalance capital had put the Bank in a good position to meet the challenges facing the industry. But with no revenue growth and a strained franking account position, the Bank will be relying on further share buybacks to maintain earnings per share and put a floor under the share price.
(This makes sense until the Government policy changes and the success of the new business model is proved.)
Fortunately, ANZ is in a very strong capital position due to the divestment of its Asian and wealth management businesses and organic capital generation. After completing its current on-market share buyback (it has around $1.1 billion remaining from its original $3 billion program) and already announced divestments, its capital ratio on September 30 (on pro-forma basis) was 11.83%. This is well in excess of APRA’s “unquestionably strong” target ratio of 10.5%.
(The bank’s better balance sheet following the Murray Inquiry is a plus for the share price, which I don’t think has been fully priced in because the Royal Commission and other regulatory issues keep detracting from the banks’ better stories.)
Because franking credits are strained, “off-market” share buybacks are off the agenda. Also, while the annual dividend of 160c per share (fully franked) is now secure, it won’t be going up. This leaves on-market share buybacks as the preferred method for returning capital.
ANZ will also “neutralise” its dividend re-investment plan (DRP), which means buying on market an equivalent number of shares to that it issues through the DRP. Along with share buybacks, this will support ANZ’s reported earnings per share.
Full year cash profit from continuing operations of $6.5 billion was down 4.7% on the previous year, but $0.3 billion better than analysts’ forecasts. It included “large and notable items” totalling almost $700 million, of which $295 million was for customer remediation costs arising from the Royal Commission and $206 million for accelerated software amortisation.
- Strong performances in Institutional and in New Zealand. The former grew second half cash profit before provisions by 7% compared to the first half. In New Zealand, cash profit before provisions grew year on year by 7%. Interestingly, cash profit in NZ has grown by almost 300% since 2010, and in 2018, total expenses (in actual Kiwi dollars) were less than those incurred in 2010;
- Bad debt provisions were at record lows. (This is another huge story that seems to have gone unnoticed and I would like you to imagine the headline hullabaloo and stock price reaction if bad debts had gone up!) The Bank booked a cost of just $688 million in FY18, down from $1,199 million in the previous year. The second half loss rate was just 9 basis points. Importantly, the forward indicators are positive and show no signs of mortgage or other financial stress;
- Total expenses (excluding large and notable items) fell by 1.5%. Excluding Asian Retail, ANZ shed 2,710 positions, with Australian Retail losing 1,000 jobs (7%). ANZ said that most of these positions went in the second half, giving ANZ a trajectory for lower costs in the next half; and
- Tier 1 capital of 11.44% at 30 September (11.83% on a proforma basis).
- A weak result for the Australian Retail Bank, ANZ’s biggest division, where a slowing housing market and constraints on investor lending took their toll. Cash profit before provisions and excluding large and notable items for the second half was down 2% on the first half. Year on year, it rose by only 2%;
(This slowdown is strongly connected to the stricter lending criteria that is slowing up loan approvals and then there is the media hysteria about a house price collapse, which would be breeding reluctant buyers for the time being.)
- Volumes were also weak – with year on year housing growth of 3% and deposit growth of 1% below system. The second half was even weaker, with housing growth slipping to 0.3% and deposits going marginally backwards. Shayne Elliott admitted that the tight control of expenses might have had some impact on volumes, implying that ANZ might have gone “too hard, too fast”; and
- Net interest margin (NIM) declined from 193 basis points in the first half to 182 basis points. Some of this was due to customer remediation and other one off factors, while a change in the asset mix played its part as ANZ focussed on (lower margin) owner occupied home loans and customers switched out of higher margin interest only loans to lower margin principal and interest loans. On the flipside, ANZ’s recent increase to the variable mortgage rate was yet to fully flow through and looking ahead, the immediate outlook for NIM was more stable.
(Customer remediation is a cost in the short-term that will work itself out over time. And provided the economic growth forecasts that economists like Deloitte Access Economics’ Chris Richardson have out there come true, then loan revenue should eventually grow at a faster rate than other Royal Commission ‘get-even’ costs as they become a thing of the past.)
The brokers and the market
The market’s initial reaction to the result was positive, with the shares up 1.05% yesterday. The analysts were on the whole a little more subdued. While noting it as a “beat”, UBS thought it was a little “messy”. Macquarie thought the result “credible”. Others were concerned about the deterioration in NIM and whether ongoing switching in the home loan market and regulator action on front book/back book pricing would put further pressure on revenue.
Overall, the major brokers remain reasonably positive about ANZ, with five buy recommendations and three neutral recommendations — no sell recommendations. The current consensus target price is $29.35, 13.2% higher than Wednesday’s closing price of $25.93. At this price, ANZ is yielding 6.17% (fully franked).
(With a targeted price rise of 13.2% coming out of the brokers crystal balls, which let’s admit aren’t always accurate, and a dividend of 6.17%, your bet on ANZ could reap you 20% in one year, but even if it took two years to materialize, my back of the envelope calculations say 25%, which would be 12.5% a year for two years or 8% plus a year over three years. That’s not a bad bet on a big four bank.)
Macquarie got it right in labelling it a “credible” result. I continue to believe that the major banks are “cheap” and ANZ’s result has done nothing to shake my confidence. While it is going to remain “revenue challenged”, the dividend is secure, capital position is strong and it is the most advanced of the major banks in simplifying its business and products to cut costs. Sentiment on the banking sector remains negative, so you can afford to be patient and buy on market dips.
(I think the local economy will get stronger over the next two years, wages will start to rise and interest rates will start to sneak up. The lower house prices — a correction — will bring in bargain hunters, let’s call them new borrowers, and over time the lending criteria will be less strict, so bank profits will sneak up and the share price will anticipate this. This ANZ result does not make me doubt my cautiously positive view on banks, which look like a sensible buy when the market overreacts.)
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