Australia | Nov 22 2006
By Chris Shaw
Yes the Australian banking sector is expensive, even at a time when interest rates are rising, bad debts are expected to follow suit and credit growth is slowing. Merrill Lynch’s response is along the lines of “So what?”, the broker retaining its Overweight call on the sector despite the banks being 5-7% above fair value.
On the broker’s numbers the banks should still record pre-provision earnings growth of around 13% this year, which works out at about 10% growth in earnings per share terms.
This still looks good compared to the broader market, as the broker expects industrials to post 5-6% earnings growth in FY07. This means the banks have retained their status as a defensive investment class, particularly as on the broker’s numbers the industrials sector is likely to face earnings downgrades of 4-5% in coming months.
The negatives of slowing credit growth and potentially higher bad debts are likely in its view to be offset by strength in business banking, while the broker also points out improvements in deposit harvesting could add as much as 2-3% to earnings per share growth. Following the latest profit results the broker has lifted its sector earnings estimates by around 1%, so the trend for earnings surprise remains to the upside.
In order of preference the broker rates St George Bank (SGB) as its top pick, as the broker expects the bank’s small to medium sized enterprise (SME) franchise model to deliver earnings growth above that of its peers in the medium-term.
Second on the list is Westpac (WBC), which it suggests is still undervalued despite recent strength, with the order among the remaining majors is ANZ Banking Group (ANZ), National Australia Bank (NAB) and Commonwealth Bank (CBA).