Weekly Broker Wrap: Banks Are Being Squeezed, Telstra Turns Around

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

By Eva Brocklehurst

So the Reserve Bank has cut the official cash rate by 25bps to 3.25%.

What this means has come to be quite different for various business sectors and elements of the population. Once upon a time the word rate cut was pretty universally welcomed. Mortgage rates would come down, albeit with a bit of a lag, people would spend the extra money on purchases rather than pay down their debt and companies would feel more comfortable adding a bit of leverage. In terms of the RBA's desire to provoke a sluggish economy to move up a gear,  it worked.

Now, the community observing these moves is more sanguine and analysts and economists see it working less smoothly. Why? Well, it's probably all to do with the Global Financial Crisis, which five years ago ushered in a financially more sombre world.

Goldman Sachs analysts consider stocks that outperformed in the wake of the GFC were those that are typically called defensive, or those that could benefit from the rash of interest rate easing that was triggered worldwide. Safe as a bank? Not anymore it would seem. This sector, heavily entangled with Europe's debt problems, is still a long way from pre-crisis peaks. Ahead, Goldman thinks this will continue as long as these sovereign risks play out in Europe.

How are the Aussie banks faring? We've been told they are at the top of the heap when it comes to beating the European contagion. Well, they are, but they're still feeling the pinch. Many brokers agree that the business banking margins of the major banks are under pressure, and this is primarily due to an inability to re-price debt (Macquarie and JP Morgan) and, on the ground, a potential shortage of high margin business from Western Australia and to a lesser degree Queensland  (Macquarie). Macquarie has downgraded the banks' earnings forecasts by 1-2% in FY13, adjusting ANZ Banking Group ((ANZ)) and Commonwealth Bank ((CBA)) earnings the least (up 0.4% and down 1% respectively) and Westpac ((WBC)) and National Australia ((NAB)) the most (down 1.5% and 1.2% respectively). The broker continues to prefer ANZ and NAB, although wary of NAB's Western Australia and Queensland exposure. For CBA, while the return on equity decline theme remains intact, Macquarie's recent analysis has shed a relatively more positive light on the stock. This, along with its safer book, is enough for Macquarie to shift CBA to a Hold from Underperform.

WBC now becomes the broker's least preferred bank. Macquarie says pressure on margins is unsurprising given the lack of demand for credit, the excess liquidity available at the larger end of the market and the reluctance to write business below investment grade. Australian banks have benefited from strong loan growth and margin from the mining/energy boom and a slowdown in that quarter implies a more subdued growth outlook. Business banking margin decline was also exacerbated by a shift towards safer, but  higher cost, term deposits. Macquarie has introduced its 'Spotlight 4' — a scorecard which provides a view on the outlook for loan growth, margins and lending fees. Analysis shows that on a relative basis, unlike the other majors, the loan growth outlook for CBA appears to be improving, albeit off a low base.

JP Morgan observes that deposit competition, and 'maxed-out' wholesale markets, are blunting the impact of rate cuts, and creating a vicious circle such that the official easing is compelled to continue. The broker noted that, as the overnight cash rate declines, an increasingly larger pool of deposits will become the subject of margin compression as asset yields push closer to low-rate deposits.This dynamic gets worse the lower the cash rate falls, given more of the deposit base is re-priced towards zero. Now, extrapolating this, according to the broker, could even mean rate cuts do not get passed on at all!

The calculation looks like this: Each 25bp reduction in the overnight cash rate requires around 4bps of re-pricing on the mortgage book to be fully recovered. Put lower returns on free funds and deposit compression into the mix and this re-pricing looks like being placed in the too-hard basket. JP Morgan maintains the banks have a long-established track record of re-pricing loans to manage higher funding costs and the mortgage book (accounting for 55% to 65% of loan portfolios) has been the primary re-pricing mechanism. So, the broker believes Australian banks are fully valued at current levels and there is no discount for the probability of an elevation in loan losses above current consensus estimates. Hence,  no Overweight recommendations.

In this brave new world of tight credit Goldman has analysed the potential for a residential building recovery. The broker maintains a more modest rate of household mortgage lending does not preclude a recovery in residential construction activity, as new residential construction represents only a small proportion of credit growth. Transactions associated with the established housing market and structural leveraging trends are a far bigger driver of credit growth both in absolute size and variability, it would seem. Indeed, Goldman is forecasting a 30% recovery in housing starts out to 2014, which could be accommodated by an acceleration in credit growth of just 1.0ppt-1.5ppt. Moreover, credit growth would not need to accelerate at all if the savings rate increased by a further 1.5ppt.

The broker maintains changes in the Queensland state budget have strengthened first home buyer subsidies for new construction in that state at the expense of established housing. Additionally, evidence is building that the downtrend in house prices has stabilised with tentative signs of recovery. The thesis is that falling house prices can act to discourage an individual’s decision to build a new home. As such the cessation of house price declines should act as an important catalyst for a pick-up in construction, given the other fundamentals in place.

And now for something completely different?

Well, perhaps not completely as it's still about money. As the billions are being spent rolling out the National Broadband Network across Australia RBS has looked at the market share of Telstra ((TLS)) and Optus ((SGT)) and TPG ((TPM)). Telstra is seen increasing market share by 0.6ppt in six months to June 2012. Meanwhile, TPG added 0.2ppt and Optus lost 0.3ppt.

RBS estimates fixed broadband revenue grew by 3.9% in the six months to 30 June 2012, an improvement on the 1.8% growth in the prior half. Household penetration grew to 65.3% in the second half from 64.2% in the first. Telstra’s Average Revenue Per Unit (ARPU) growth has made a material turnaround at 3.2% in 2H12, versus 0.3% in 1H12 and minus 5.6% in 2H11. It's seen as stable and RBS has a Hold recommendation and target price of $3.85. Meanwhile, iiNet ((IIN)) is acquiring market share and has become the broker's preferred pick in the sector with a Buy rating and target price of $3.93. 

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