Rudi On Thursday

This story features ANZ GROUP HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: ANZ

I don’t have a car. The positive thing about this is that it helps me contain my carbon footprint. And I don’t get anxiety attacks when I see forecasts of petrol possibly hitting $1.80 per litre at the pump.

Sometimes, however, not having a car can be a nuisance. Like when your commercial partner wants to see you at his office which is located at a rather inconvenient spot for those who travel by public transport, or when your new partner wants to have a meeting at his offices which are even further away from any public transport connection. Those Foxtel studios are not exactly close to the Sydney CBD either. That’s why, every once in a while, you’ll see me travelling by cab.

Three out of five cabdrivers who drove me to my destinations recently told me they have been buying banking shares, as banking shares are cheap, you know, and they pay a handsome dividend, while the chances that any bank in Australia will ever end up like Northern Rock or, heaven forbid, Bear Stearns, should simply be dismissed.

You’ll have to take a longer term view, but I am in no hurry, the last cabbie told me. I could almost sense his two colleagues nodding in the background, even though they were probably driving around in different parts of the city at that time, unaware that I was yet again being initiated in the art of long term investing by one of their share market savvy colleagues.

If you wonder whether numbers one and four deliberately avoid the banks, or don’t invest in the share market at all, I simply cannot tell you. Our conversations while traveling to my destination never touched upon the subject. It was only after I’d said goodbye to number five that I realised investing in sold-down banking stocks had turned into a regular conversation during my taxi rides.

As the market adage goes, when your brother in law starts giving you investment tips at the family BBQ, or your barber, or the cab driver, it is usually time to head for the exit. The Australian share market closed today at a three month low. So what does this tell me?

I don’t know the answer. What I do know, however, is that banking shares have sunk lower than many an expert would have thought possible. ANZ Bank ((ANZ)) shares even closed below $18 on Tuesday (they recovered strongly on Wednesday but are still trading more than 24% below their average price target).

I noticed the average forward looking Price-Earnings Ratio (PER) for the sector fell to a low 9x earlier this week. That is as low as the sector has been priced over the past decade, albeit that it has now happened twice within a space of four months (March and June).

The last time banking stocks were priced at a PE multiple of low 9x was in 1995-1996; when the sector climbed out of the doldrums from “the recession Australia had to have”. Prior and during this recession valuations for the sector had dropped even lower, but one also has to remember that those were the years of heavily damaged balance sheets and many loan books gone wrong. Westpac only survived because of a brazen Kerry Packer, or so the legend goes.

I had a quick look at what the recent carnage for banking stocks actually means for those investors willing to follow into the footsteps of my three cabbie-advisors. At $18.62, which is Wednesday’s closing price for ANZ (up more than 3.7% for the day), the shares are offering a projected FY09 dividend yield of nearly 8% (7.8% to be precise).

Consensus market expectation sees earnings per share take a massive haircut this financial year (decline of 7.4%) but a strong recovery in fiscal 2009 (currently up 10%). The end result should be that ANZ’s net profits should slightly beat last year’s profits in 2009. Even if you don’t believe in these projections, and things won’t pick up as much as currently anticipated by securities analysts, you’re still getting ANZ at a FY09 multiple of 9.5 – no profit growth included.

Those three cabbie-investors, by the way, all prefer Commonwealth Bank ((CBA)) -all three of them- and to a lesser degree Westpac ((WBC)), which was only mentioned by one cabbie. When I checked their wisdom on the FNArena website I discovered their view is currently a perfect reflection of the market’s preference when it comes to valuing major Australian banking shares: CommBank shares are at present enjoying the highest valuation in the sector (FY09 multiple of 10.3) with Westpac coming second (FY09 multiple of 9.9).

When I compared earnings forecasts by securities analysts, their price targets and implied projected valuation multiples for the sector, I discovered a similar preference: first comes CommBank, then Westpac, followed by National Australia Bank ((NAB)), with ANZ at the end of the queue. (I’ll leave out St George Bank ((SGB)) given it is about to disappear from the market as a separate entity).

I also discovered that current average price targets for the major banks imply that only CommBank will eventually be trading at the long term sector average, which is at 12.5 times forward projected EPS (FY09). The others are expected to merely return to multiples of 11x-something. (Last year all banks were trading at multiples of 15x and higher).

Contrary to what some among you might now be thinking, the above paragraph is not so strange as it looks at prima facie. During my recent research into PERs of banking stocks over the past fifteen years, I discovered that what is often mentioned as the benchmark long term valuation for banking stocks -a forward PER of 12.5- is in fact a very rare occurrance.

To put it very simply: banking stocks very rarely trade on a PER of 12.5. When they do it is almost every time temporarily on their way down from a higher multiple to a lower one, or vice versa on their way up during a re-rating, and thus banks seldom trade at 12.5x next year’s earnings per share.

What this means, and this has now been backed up by my own research, is that bank shares either trade at 13-14 times projected EPS, with the occasional peak above 15, or they trade at 10-11 times next year’s EPS, with the occasional dip into 9x. Over the longer term this averages out to something close to 12.5.

The exception to the above is the recession of the early nineties when PE ratios for the banks were shot to pieces. As I said earlier, the market would be very harsh on the banks were it to give them a similar treatment this time around.

I can only admit, I am surprised by the wisdom of my three cabbie-investors. Maybe I should stop reading so many broker research reports and travel by taxi more often?

Till next week,

Your editor,

Rudi Filapek-Vandyck
(as always firmly supported by Todd, George, Grahame, Greg, Chris, Paula, Joyce, Pat and Sarah)

Click to view our Glossary of Financial Terms