ANZ Result: Stock And Sector Implications

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

– ANZ lifts lagging dividend payout
– Revenue growth questioned by some
– Will the other banks now be forced to lift payouts?

By Greg Peel

“We believe focusing purely on short term dividend yield as a valuation methodology is fundamentally flawed for all banks,” insists UBS.

Tell that to the market, which yesterday sent ANZ Bank ((ANZ)) shares surging 5.8% despite a quite remarkable sector rally since June. Obviously that’s what the UBS analysts are at pains to do. But if Gordon Gekko were operating today, his mantra would likely be Yield is Good.

Last night US tech giant Apple successfully issued US$17bn in corporate bonds, an issue oversubscribed from an initial US$15bn intention, to mark the biggest corporate bond issue in US history. It is of little surprise the issue proved popular in a market thirsty for investment grade paper to deliver returns simply not available from traditional Treasuries. It is notable that Apple plans to use the funds raised to underpin an intention to become the largest dividend payer in the world, as well as to buy back shares.

Dividends from debt. Many a company/fund has come unstuck in the past funnelling borrowings to shareholders (recall Telstra’s dark days). By contrast, Woodside Petroleum’s decision last week to become a yield play rather than a growth play (better yield than any of the banks or Telstra) was all about drawing on substantial cash flows. Woodside may not grow in the near term but its distributions are unquestionable. Banks, on the other hand, by their very nature are paying dividends from debt. Banks cannot be equated to Apple, because debt is a bank’s fundamental business. But…

“While yield is important, especially in a QE world, dividends are a function of ROE [return on equity] and growth opportunities,” rails UBS. “Bank dividends are also a result of significant leverage, they are not annuities”. [UBS emphasis]

Investors will nevertheless be pleased to learn that not all brokers are as outspoken as UBS in the wake of ANZ’s result and increased dividend. Indeed, some are quite positive.

Yesterday ANZ announced a $3.2bn interim profit which represented 8.5% growth on the second half of FY12 and 9.9% growth year on year. The result beat market consensus by 2%, although largely matched or even fell short of many of the major brokers in the FNArena database. The “beat” came down mostly to better than expected cost cutting and lower than expected bad debt charges. But it was not the result itself which caused all the fuss, nor caused the big jump in share price. ANZ’s announced 73c interim dividend beat just about every forecast, for which consensus sat at around 67c after brokers factored in their own dividend increase expectations. It was not the increase which surprised, it was the quantum.

More significantly, ANZ announced a target dividend payout ratio of 65-70% of earnings, with a bias towards the upside of the range. This lofty interim is hence no “special”, but represents a shift towards a higher ongoing yield for shareholders. ANZ’s previous target was simply 65%, and this interim represents 67%.

ANZ’s payout ratio has for some time lagged that of Big Four peers. At 70%, ANZ will still sit behind National Bank ((NAB)) on 75%, Commonwealth Bank ((CBA)) on 76% and Westpac ((WBC)) on 79%. The shortfall is not implicit of any inferiority on the part of ANZ’s business, rather ANZ is unique among peers post GFC in investing in growth outside the domestic market, establishing a presence in Asia. The bank has thus sacrificed distribution for growth, and will continue to do so. By contrast, NAB would dearly love to exit its ill-fated UK business and CBA and Westpac remain firmly rooted downunder.

That said, ANZ’s performance since last year’s full-year profit result release in October has been “plagued”, as JP Morgan puts it, by margin deterioration, stemming from above-peer exposure to institutional banking and to New Zealand. The good news is that JP Morgan sees margin pressure headwinds now easing in those sectors. It is also a positive that the bank has reduced costs by moving to a single brand in New Zealand, and more importantly by having reached a point of critical mass in Asia, JPM, notes, such that incremental revenue is now exceeding incremental cost.

ANZ has unwound recent underperformance and closed the yield gap, and JP Morgan suggests the bank can meet its payout guidance while still allowing capacity for further investment. JPM’s sector-relative rating for ANZ remains at Neutral but the analysts see yield as providing ongoing support now that RBA rate cut expectations are back in vogue.

Goldman Sachs calculates ANZ to be trading at 2x its net tangible asset valuation, which would make the shares 5-10% expensive. But a sustainable return on total equity (ROTE) of around 17.5% implies ANZ should trade at a discount of 12% to peers, and the stock is trading at 15% (even taking yesterday’s jump into account). This conundrum leaves Goldman on Neutral.

While cost and bad debt reductions are positives, CIMB points out that market share gains and a bounce in trading income in the half masked the fact ANZ’s revenues were weak. Net interest margin – a bank’s fundamental measure – fell three basis points. The increased payout ratio is welcomed but CIMB suggests bank capital requirements will restrain ANZ from any further capital management before FY16. ANZ elected to increase its ratio rather than buy back, or “neutralise”, its dividend reinvestment plan (DRP) discounted shares.

CIMB is sticking to Neutral, suggesting the environment remains “hostile” for ANZ compared to peers. The analysts do not concur with JP Morgan that margin pressure is now over in institutional and Asian lending, and while peers have enjoyed repricing gains on mortgages (that is, by not cutting rates by as much as the RBA), ANZ is relatively underweight mortgages.

UBS, unsurprisingly, on the strength of the above quotes, is maintaining a Sell rating. The analysts also point out ANZ is now trading at no less than a 32% premium to leading Asian banking franchises such as Standard Chartered. Morgan Stanley (Underweight) believes FY13 will be as good as it gets for ANZ. Revenue growth will be limited, the analysts suggest, and the Asian expansion will continue to impact on return on equity.

BA-Merrill Lynch, on the other hand, has retained a Buy rating. Credit Suisse (Outperform) suggests ANZ offers best in sector productivity, growth via Asia, a catch-up on capital management and below peer valuation. Deutsche Bank (Buy) believes, unlike CIMB, that ANZ could indeed buy back its DRP in due course while still maintaining the new payout ratio and organically generating capital.

Macquarie is arguably the most outspoken database broker on the positive side. Yesterday’s jump in share price was clearly all about the dividend, Macquarie acknowledges, but the analysts believe “a bigger re-rate” is in store once the market comes to realise the optionality ANZ enjoys in earnings potential in Asia and more focus on mortgages and SMEs domestically.

This superior earnings performance along with a commitment to pay out more,” suggests Macquarie, “should see better than peer dividend and stock price growth”.

Broker opinions, therefore, are not offering much solace for the uncertain investor. UBS is screaming “don’t buy banks just for dividends” on the one hand and Macquarie is lauding ANZ’s above peer dividend growth on other. Such division only serves to highlight the conundrum that is bank share investment in the post-GFC world. If you had told brokers in June last year that the banks were all going to rally around 70% in under a year they all would have fallen about laughing. Where on earth would earnings growth come from?

And that’s the point. Yesterday’s monthly private sector credit growth data from the RBA highlighted the fact banks have little source of earnings growth at present, at least not enough to justify such sterling market outperformance. But they are offering strong yields, making them domestically sought after and globally a must-have. When will the music stop?

The next question is as to whether an increased payout ratio from ANZ provides any suggestion that the other banks will follow suit.

The starting point for this argument is that an increase to a target 70% payout still leaves ANZ short of all three peers in the payout ratio stakes. On first glance one might thus assume that ANZ’s catch-up of sorts puts no pressure on the others to further widen the gap. But Morgan Stanley does see some scope.

Not for NAB though. In FY12 NAB maintained the quantum of its dividend despite a decline in earnings which by default lifted the bank’s payout ratio to 75%. Morgan Stanley believes NAB could actually lift to 76% for FY13 but that would represent a peak, with the analysts citing relatively low returns as cause for that ratio to fall back towards 70% over the next few years.

CBA has the scope to lift its ratio from an expected 76% in FY13 given the bank revised its payout ratio at the FY12 result to a range of 70-80% and has a requisite mix of high returns and franking generation, Morgan Stanley notes. The problem is CBA’s guidance at that point was for a dividend that would “likely be slightly lower” in FY13 from FY12 so management would have to suddenly change guidance after nine months. Note that CBA runs on a June-end year rather than the September-end year of the other three and will only provide a quarterly update this round, not an interim result.

Westpac also has the scope for a lift, the analysts point out. Yet the bank has gradually increased its ratio from FY10 to a forecast peer-beating 79% consistent with guidance to “maintain a payout ratio that is sustainable in the long term”. Long term sustainability would not include a sudden “anything you can do” response to ANZ, one would assume. Yet given an excess of franking credits, Morgan Stanley would not rule out a special dividend from Westpac, albeit the analysts believe the most likely capital management outcome, if any, would be a DRP buyback.

Meanwhile, the FNArena database shows five Buy or equivalent ratings for ANZ, two Holds and one Sell, with no changes stemming from the result announcement. The consensus price target has been lifted to $29.70 from $28.55 previously, but this still suggests 7% downside from the current share price.

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