Earnings Season: How Will The Banks Stack Up?

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

-Capital targets back in focus
-Competition for business banking
-Capital returns likely limited
 

By Eva Brocklehurst

Is it time to reassess the major banks? The sector has outperformed the broader market so far this year but several brokers think the banks may sell off over the next few months, with some key earnings reports on the way. Three major banks will report interim earnings over the next week or so. ANZ Bank ((ANZ)) on May 1, Westpac ((WBC)) on May 5 and National Australia Bank ((NAB)) on May 8. Commonwealth Bank ((CBA)) will deliver a quarterly trading update on May 14. Diversified financial Macquarie Group ((MQG)) will post FY14 results on May 2.

Overall, UBS notes credit growth has picked up, especially in housing. UBS expects limited capital management beyond dividends during the current earnings season, as the banks strengthen their capital ratios to meet banking system requirements. Potential upgrades are likely to come from cyclical sources such as lower bad debts and higher trading income but UBS would not be surprised to see the banks sell off through the reporting season. The major issues in Morgan Stanley's view centre on revenue growth and capital generation, with less emphasis on lower bad debts as a driver of share prices. Macquarie expects the impairment picture will improve across the sector, while capital generation should be strong at both Westpac and NAB. The broker thinks margins are still likely to be under pressure, particularly at ANZ and NAB, as competition for business banking continues.

UBS observes commentary around loss of mortgage share implies Westpac has used price discounting as a lever. The broker dismisses this as more a case of the bank getting its portfolio mix right. UBS acknowledges significant discounting is present across the major banks, but senses that Westpac has it mostly isolated to the St George brand. The broker also thinks bad debt charges should remain low at the bank. Given the acquisition of the Lloyds assets, UBS expects Westpac's CET1 (common equity tier 1) capital ratio to be 26 basis points lower at 8.84%. Neutralising the bank's Dividend Reinvestment Plan (DRP) and special dividends are considered more likely when this figure returns above the market's 9.0% comfort level.

Citi has downgraded recommendations on two of the three majors ahead of the results. The broker believes capital target ratios are back in focus and in this case Westpac is the best positioned to revise target ranges. Nevertheless, the uncertainty over capital targets means this broker also thinks it likely the special dividends are on hold for now. Citi's recommendation is downgraded to Neutral from Buy, as the stock has been the stand-out performer in the outperforming banking sector over the last three months. The other stock which has been downgraded is NAB – to Sell from Neutral. Citi thinks NAB's performance has been the weaker of the big banks while lacklustre demand for business lending is expected to continue to impact earnings growth.

UBS is also concerned about the revenue result for NAB. The first quarter update showed flat pre-provision profits and this looks likely to continue. UBS expects margins to be the focus of NAB's result, with significant ongoing pressure in business lending as well as mortgages. Morgan Stanley expects NAB's share price to fall. The broker expects the first half result will highlight headwinds in business banking revenue and an end to the positive surprises on costs. The broker also thinks normalising loan losses in Australia and strong earnings recovery in the UK is priced in, while the path to an exit from the UK remains difficult.

Goldman Sachs actually prefers NAB, given the low credit growth environment. Despite solid fundamentals the broker considers bank valuations overall are stretched. The broker favours those banks where sustainable profitability is not reflected in valuations. To this end, the assessment of NAB's sustainable returns implies the stock should trade at a 12% discount to peers compared with the current discount of 17%.

ANZ is expected to provide a solid first half result and BA-Merrill Lynch expects cash earnings to have risen 11% on the first half of FY13. Asian trade finance margins have stabilised and, while this is a relatively modest contributor to earnings, it is integral to the bank's regional expansion and important for sentiment on the stock, in the broker's view. Having said that, Merrills thinks the share price reflects all this and remains cautious on the Asian macro outlook for the rest of 2014, noting ANZ has most downside risk among the major banks. The broker retains an Underperform rating. ANZ is the bank most likely to cancel neutralising the DRP in order to preserve capital and this is the key negative surprise that Merrills expects from the result. 

ANZ is likely to be the strongest performer in the commercial banking group this season, with cost discipline and both housing and non-housing growth, according to Credit Suisse. UBS believes the bank will be buoyed by good cost control, currency benefits and lending growth in the domestic business. Asset quality improvements should offset losses on some large resource exposures.

Morgan Stanley expects Commonwealth Bank's share price to rise, with the trading update leading to upgrades to earnings estimates, underpinned by a combination of solid home loan growth and stable retail bank margins. The broker notes the stock has underperformed the major bank average in the year to date and its price/earnings premium to peers is only 8% versus a one-year rolling average of 13%.

According to Goldman Sachs, Macquarie Group should be underpinned by an improvement in impairments and strong commodity trading performance. The broker's activity data suggests the diversified financial group has benefited from recent IPO activity in Australia and abroad, with the completion of a series of deals supporting a solid second half performance. Credit Suisse expects Macquarie's profit to be up around 40-45% on FY13.

Looking At The Forecasts

When FNArena last assessed the big banks back in March, in the wake of CBA's interim and quarterly updates from ANZ and NAB, the comparative table looked like this:
 

 

ANZ was the most preferred bank on the basis of the FNArena broker Buy/Hold/Sell ratio (B/H/S) and CBA the least. This was despite NAB showing a greater upside to the consensus target (7.02%) than ANZ (4.08%). Westpac and NAB's targets had already been exceeded.

It is FNArena's reliable observation that when bank share prices exceed targets, either targets have to rise or share prices have to fall. If we now take a look at the standings today (below), using yesterday's closing prices, only NAB (2.39%) continues to trade below its target, and only just. All the other three have now exceeded their targets, including ANZ which has flipped over completely (-4.69%) to be the most "overvalued". Yet on a B/H/S basis, ANZ is still preferred over NAB.

But this may be about to change come results publications, or not. If brokers are given no reason to raise their ANZ target prices, ANZ's share price must, in FNArena's experience, fall. Ditto for Westpac and CBA, but then CBA has maintained an "overvalued" price against broker targets for, oh, years now.

 

 

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