Weekly Broker Wrap: Bank Result Previews And Macro Themes

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 – GS strategists identify dominant macro market themes
 – Stockbrokers preview major banks' interim results
 – RBA rate cuts to have little market impact, predicts JP Morgan
 – BA-ML updates views of London clients

By Chris Shaw

While 2012 has delivered a relatively positive start in terms of equity market performance, Goldman Sachs expects a number of macro themes will continue to influence sector and stock selection for the Australian market.

The key macro themes expected to dominate Australian stock performance over the next 12 months are a US economy recovery, China's ongoing industrialisation and growth, mining capital investment, mining volumes and the domestic interest rate cycle.

Of note, Goldman Sachs points out the China industrialisation and growth plus the mining investment themes are highly correlated and have been the dominant drivers of performance over the past year. At the same time, domestic cyclicals have underperformed the market since the end of 2010, though performance within this group has been mixed given weak building material performance and outperformance from the transport sub-sector.

The US economic recovery theme has modestly outperformed since the end of the GFC and has gained momentum since late last year. Goldman Sachs notes a strong Australian dollar rally since the middle of 2010 has reduced the attractiveness of this theme for domestic investors.

Looking ahead, Goldman Sachs continues to view the US recovery themes as one of the more attractive given its long duration potential and the added benefit of offering a currency hedge against any Australian dollar weakness. Preferred stocks for such a theme are Amcor ((AMC)), Brambles (BXB)), Computershare ((CPU)), CSL ((CSL)), James Hardie ((JHX)), News Corp ((NWS)) and Sims ((SGM)).

Domestic cyclicals offer attractive earnings leverage to lower interest rates and the sector offers some value in the view of Goldman Sachs, but improved performance will require the easing of structural headwinds such as an increase in household savings and the recent strength in the Australian dollar. Preferred exposures for the domestic cyclicals at present include OneSteel ((OST)), Super Retail ((SUL)) and Qantas ((QAN)).

In exposure to Chinese growth and its impact on mining investment, Goldman Sachs expects coming years will see the resource sector move from a “delta price” to a “delta volume” environment, which would move most key commodities into surplus conditions. This leaves Goldman Sachs increasingly cautious on the ability of the resources sector to maintain its outperformance relative to the market. 

Assuming mining volumes increase, exposure to a strong capital investment cycle and an increase in volumes is preferred. Goldman Sachs likes Asciano ((AIO)), Orica ((ORI)) and UGL ((UGL)) for playing this theme. 

May means major banks reporting season in Australia and brokers have been updating expectations for the sector in anticipation of the results in coming weeks. Results are expected for ANZ Banking Group on May 2, Westpac ((WBC)) on May 3 and National Australia Bank ((NAB)) on May 10. Commonwealth Bank ((CBA)) will provide a trading update on May 17.

Of particular interest has been the outlook for margin pressures, cost out progress and the source of business loan growth. In general, Macquarie expects the results from ANZ, Westpac and National Australia Bank will show marginal earnings growth.

This reflects a subdued outlook for the sector, as while a mix of out-of-cycle interest rate rises and the retention of rate cuts may help control margins, it will come at the expense of increased risks with respect to softer loan growth in Macquarie's view.

Dividends are also a concern, as while payouts are sustainable, Macquarie suggests softer earnings growth is likely to see dividends decline at the absolute level. Bad debts may exacerbate this trend in the broker's view.

With respect to bad debt levels, Macquarie's review of asset quality suggests the major banks are well provisioned against a slight deterioration in the broader economy. It would take further deterioration for there to be any further significant impact on impairments in the broker's view.

Macquarie expects margins among the banks to come under pressure from higher wholesale and deposit costs eroding retail and business margins, while there is also the view institutional growth is hiding some very soft business and retail SME loan growth numbers.

Currently improving mortgage loan growth may prove to be temporary, suggests Macquarie, while wealth operations are also expected to continue to struggle given still weak market conditions. Macquarie's order of preference is ANZ and Westpac as its preferred plays, while National Australia Bank is rated as Neutral given its exposure to the poorly performing UK economy.

UBS also expects solid interim earnings results for the major banks, the major drivers being subdued loan growth and solid deposits, net interest margin, a potential bounce-back in trading income, more aggressive cost management and patchy bad debt outcomes.

Given this backdrop, UBS has looked at where bank earnings could surprise in 1H12. On a bank by bank basis, UBS expects ANZ will show good net interest margin performance, a trading rebound and 4% revenue growth, while the major question will be return on equity from the bank's Asian assets.

For National Australia Bank the expectation of UBS is for pressure on net interest margin, weak personal banking revenue but strength in the business bank operations. For Westpac, UBS sees a trading rebound in the second quarter, subdued asset growth and cost pressures.

In terms of forecasts for the upcoming bank results, Macquarie is forecasting cash profit for ANZ of $2,964 million, which would equate to cash earnings per share (EPS) of 107c. UBS is a little higher, forecasting cash EPS for ANZ of 112.6c. Macquarie suggests an institutional rebound and cost containment in New Zealand are potential sources of upside in the result. 

For National Bank UBS expects cash EPS of 125.2c, while Macquarie is forecasting cash EPS of 123c. The latter sees the maintaining of margins, reasonable asset growth and continued momentum in the wealth operations as potential sources of upside to the result.

Westpac is expected to report cash EPS of 103.1c for the period according to UBS, while Macquarie's forecast stands at 101c. Good cost containment, solid margin performance and a rebound in trading profits offer possible sources of upside surprise in the view of Macquarie.

Post a recent rally the major Australian banks are not cheap in the view of UBS, as the sector is trading on a price to book ratio of 1.7 times, a FY12 earnings multiple of 11 times and a 6.8% dividend yield.

In contrast, RBS Australia expects European tensions will escalate over the next few months and under such a scenario the Australian banks are attractive given relative earnings certainty and yield support. The banks are also expected to benefit from further cuts to interest rates in Australia given pricing power should moderate the effect of funding cost headwinds.

Order of preference for RBS is National Bank and ANZ as most preferred, this due to their better positioning for structurally lower mortgage credit growth and cyclical improvement in business credit growth. As well, RBS sees NAB and ANZ as having less reliance on wholesale funding markets, while both appear better positioned for the new Basel III regulations. 

In terms of the market's overall view on Australian banks, the FNArena database shows Sentiment Indicator readings of 0.5 for National Bank and Westpac, 0.4 for ANZ, and minus 0.1 for CBA. 

In the view of JP Morgan, a low March quarter CPI outcome in Australia opens the door for a Reserve Bank of Australia (RBA) easing of interest rates, but this is unlikely to lift the domestic equity market out of its current range as a lot of easing is already priced in.

The benign CPI number changes the policy settings needed to hit the RBA's objective of keeping the non-mining economy cornered to keep medium-term inflation risks at bay. This makes an easing likely, but JP Morgan points out the market is already factoring in three rate cuts this year. As a result, the broker suggests the exact level of the cash rate is a secondary issue for equities.

JP Morgan agrees official interest rates are likely going to come down but this implies some earnings risk, particularly because of the ongoing struggles in the Australian housing market. On the flip side, JP Morgan suggests the bank sector is not the correct way to play a move to lower interest rates, as if the unemployment rate rises fast enough to move interest rates to a lower level than already anticipated, there will be an increase in loan quality risks. This would likely be enough to offset any potential upside in credit growth.

An alternative would be a play on the currency, but again JP Morgan notes the market is already well down this path. While there is logic to such an approach the broker suggests finding value using this approach is a more difficult issue at present.

JP Morgan continues to lean towards stocks and sectors with value drivers largely independent of the macro environment or are priced for low expectations. This includes Insurance, Energy and companies struggling from cyclical factors but with a reasonable industry structure. These include the likes of Computershare ((CPU)), Boral ((BLD)), Sims ((SGM)) and Aristocrat Leisure ((ALL)). 

In a recent meeting with its London clients, BA Merrill Lynch notes the dominant view on the market at present is a continuation of the current trading range. This reflects a lack of conviction and willingness to take risks, though investors are looking to add rather than subtract risk as their next move.

There remains some concern over the pace of US economic activity, while BA-ML notes growth in Europe is viewed as a disaster everywhere except Germany. On a more positive note, a soft landing in China is seen as offsetting the weak European outlook.

A majority of clients continue to expect QE3, but BA-ML notes this is only likely after a sharp turn lower in data. There was some interest on the part of clients in BA-ML's favourite trade for the June quarter, which is long China and short US consumer discretionary.

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