Rudi’s View: Westpac Is The Evidence

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

By Rudi Filapek-Vandyck, Editor FNArena

If you think the present sell-off is only about worst case scenarios in Greece (or: Southern Europe) and about investors showing their disgust with the Rudd government's proposal for a RSPT (Resources Super Profit Tax – get used to the acronym) then maybe this is the time to rethink your market view.

Admittedly, the above mentioned factors are dominating all the headlines and views on financial television, but behind them lies a truth that is yet to catch the expert's attention: earnings estimates are no longer rising in Australia and thus the share market will start looking expensive every time the S&P ASX 200 index moves closer to the 5000 level.

The most obvious evidence of this has been provided by the banks in Australia these past two weeks. Prior to their interim updates, valuation multiples looked pretty full for all except National Australia Bank ((NAB)), leaving the obvious question of how much more upside could be created by these interim results reports?

The answer has been straightforward, but very disappointing for investors wearing rosy glasses. Bank of Queensland ((BOQ)) disappointed, but ANZ Bank ((ANZ)) did not, yet stockbrokers could not see enough reasons to further increase estimates and/or price targets.

And then came Westpac ((WBC)). At face value, the reported cash profit came out higher than analyst expectations, but so did the decline in net interest margins. The result was for everyone to see in today's edition of FNArena's Australian Broker Call Report: six downgrades in ratings by major stockbrokerages in Australia.

GSJBW, soon to be renamed Goldman Sach and Partners, is not included in our standard coverage through the Australian Broker Call Report, but if it were, the number of downgrades would have been seven.

In all these years of observing and analysing the Australian share market, I cannot remember having seen a similar flood of downgrades for a major bank in Australia, especially not following a profit result that “officially” beat market expectations.

Let me take you all back to one of the conclusions I drew in mid-April when shares in CommBank ((CBA)), Westpac and ANZ were trading above consensus price targets. At the time I warned not only that Australian banks now appeared too expensively priced, I also warned that similar observations made over the past years had taught me that whenever this occurs a pullback for the broader market had never been far off.

In case you think “beginner's luck” or “pure coincidence” – my observations reach back at least six years. This is the reason why I call this my never failing market indicator.

Of course, the offset to all of the above is that share prices for Australian banks (and for most other stocks) have been in sharp decline ever since. Combining rather minor cuts to earnings forecasts and to stockbroker price targets with sharp falls in share prices should thus once again open up relatively cheap get-in opportunities.

I note, for example, that Westpac shares are now trading more than 9% below the new consensus price target, while NAB shares are staring at a gap of more than 16% (but we'll know more about the latest stockbroker updates tomorrow).

The current gap for ANZ is 15% and for CommBank, the most expensive among the Big Four, it is now in excess of 5%.

The cheapest valued of the Big Four banks, National, is now offering an implied dividend yield of 6.7% in FY11.

All of the above shows a few things:

1.) It is healthy for the share market to let out some hot air at times, as it by default creates new value opportunities

2.) Investors better not get fooled by optimistic market forecasts and views: timing still counts, as everyone can tell you who bought CBA shares near $60 and is now staring at a share price closer to $55. The difference between the two? Less than three weeks.

3.) Earnings forecasts for Australian companies have stopped rising in April and the Big Four banks are no exception

4.) Would it be logical to assume that present consensus price targets, for now at least, show investors where the valuation limits for the Australian share market are located?

5.) Regarding the old dilemma of banks versus resources, it has now become clear that Australian banks are in good health, but challenges remain and might become a tad tougher, while the Big Diversified Resources are facing their own demons in the form of a China slowdown and possible higher taxes. When it comes to potential upside as signalled by the gaps in between share prices and consensus price targets however, BHP Billiton ((BHP)) and Rio Tinto ((RIO)) have upside potential more than double the cheapest banks.

6.) The implications from all of the above are in line with the latest decisions and updates by market strategists at GSJB Were this morning. They have sought increased exposure to resources while reducing exposure to the banks through offloading Westpac shares.

7.) Banks are now Underweight in GSJBW's Model Market Porfolio, but National is still Overweight on an individual basis.

Westpac shares are now trading on Price-Earnings ratios of 12.6 (FY10) and 11.5 (FY11). According to revised market consensus forecasts, cash earnings per share are expected to grow by 22% this year (FY10) and by 9.5% only next year (FY11). Implied dividend yields are now 5.4% and 6.1% for this year and next respectively.

All these forecasts and calculations are updated daily for paying subscribers on the FNArena website (see Stock Analysis and the R-Factor).

Subscribers are also encouraged to read “Listen To What April Has To Say”, Weekly Insights, 03 May, 2010 and “Rudi's View: Watch The New Trend In Corporate Profits”, published yesterday, 05 May, 2010.

P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.

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