Treasure Chest: Banks & Exuberance

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts.

By Rudi Filapek-Vandyck

Whose Idea Is It?

Bank sector analysts at Citi and Morgan Stanley

The subject:

Australian banks

More info:

The global end-of-year rally that finished 2023 has been great for shares in Australian banks too.

The perfect illustration to back up that statement comes from shares in CommBank ((CBA)), the local sector leader, surging to a new all-time record high of $114 (intra-day) this week. The same observation also tells us that, contrary to shares in BHP Group, Rio Tinto and others, the banks have remained remarkably resilient thus far in January.

Stockbroking analysts are yet to resume their pre-Christmas research output, but already two major brokerages locally have informed their clientele it's probably best not to have too high expectations regarding the performance of bank shares in 2024.

It's about sector valuations, for sure, but more so about operational challenges and headwinds that have been largely ignored when money was flowing in because, you know, the sun was shining and everybody seemed optimistic and happy.

First up; banks are expected to see profits retreat in the year ahead, probably by some -5% on average, which means there won't be much potential to increase dividends. Leaving dividends stable will, all else remaining equal, lift the payout ratio. There's no scenario of grave economic recession baked into such forecasts.

Neither Citi nor Morgan Stanley are forecasting a deep recession, but both identify multiple headwinds and challenges that will keep a lid on how well banks can perform operationally this year. Both teams of banking sector analysts have started the fresh calendar year with a negative stance on the sector.

Morgan Stanley's concerns

The team at Morgan Stanley sees two plausible scenarios for Australian banks in the year ahead, summarised as "soft landing" and "bumpy landing".

The first scenario sees average EPS across the sector falling by -5% in FY24, but allows for a swift recovery in FY25 by some 9% in current consensus forecasts. This scenario equally keeps the door open for new share buybacks and mid-to-high-single digit dividend increases over two years.

Assuming this scenario allows the sector to largely consolidate around current trading multiples, Morgan Stanley can see a total investment return (including dividends) of 14% over the next twelve months. National Australia Bank ((NAB)) should prove the best performer, with CommBank expected to lag.

A more bumpy scenario, however, will see the unwinding of the recent rally and equally pose more question marks about dividends and the recovery in 2025. Morgan Stanley sees potential for average EPS to decline by -11% in FY24, with little prospect of a meaningful bounce in FY25.

The second scenario might see the sector return on average decline by -6% over the next twelve months with ANZ Bank ((ANZ)) expected to prove most resilient, and CommBank the most vulnerable.

Needless to say, Morgan Stanley is less optimistic about the domestic economy, expecting sector competition to heat up, and trading multiples to fall in response to less favourable outcomes at the operational level.

Citi's concerns

Citi's sector assessment acknowledges there are still positives on the horizon; asset valuations, for instance, are likely to prove more resilient than market consensus is currently prepared for. But valuations overall are seen as a "problem" post that strong rally late last year with the analysts' focus firmly on the withdrawal of liquidity this year.

Note Citi analysts: Australian banks still need to pay back some $100bn to the RBA (for the temporary facility the central bank put in place to support the sector during covid in 2020). This should in itself not pose a major problem, but it will take liquidity out of the local economy.

Citi sees further compression in retail banking, limited repricing opportunity in business banking, and falling asset prices (though P&L charges lower than expected).

All in all, Citi too expects, ultimately, the deterioration in operational dynamics will catch investors' eye, and it will lead to lower sector valuations, irrespective of "soft landing" and positive news from a more benign impact from asset devaluation.

Broker Ratings & Valuations

Citi's sector update saw the broker downgrading ratings for regional lenders Bank of Queensland ((BOQ)) and Bendigo and Adelaide Bank ((BEN)); both to Sell. Among the majors, both National Australia Bank and CommBank are equally rated Sell. ANZ Bank and Westpac ((WBC)) don't score higher than a Neutral rating.

Over at Morgan Stanley, ANZ bank is the only major with an Overweight rating, with National Australia Bank on Equal-weight and both CommBank and Westpac rated as Underweight.

In both cases valuations/price targets have been reduced across the board.

The latter brings into focus where share prices are trading in relationship to analysts' price targets for the sector. In all cases of CommBank, Westpac, National Australia Bank, Bank of Queensland and 'Bendelaide' share prices have exceeded consensus price targets with only CommBank and Bendelaide scheduled to report interim financials in February.

ANZ Bank shares are still below consensus price target, albeit not by much.

The other banks reported in October-November and price targets are thus relatively "fresh" still. Once upon a time, bank share prices universally trading above price targets served as a signal of investor exuberance, not simply for the sector generally, but for the share market as a whole.

As a matter of fact, for many years I personally used this sector indicator as a relatively reliable signal for a pending share market pullback. At the beginning of 2024, it's now simply an additional dilemma for investors to take on board.

Below is a general sector overview as at January 17. Also included are Macquarie Group ((MQG)), Suncorp Group ((SUN)), and junior challenger Judo Capital Holdings ((JDO)).

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