Are Australian Banks Overpriced?

Australia | Mar 14 2024

Australian major bank share prices have been pushing ever higher recently despite lower forecast earnings and elevated PE multiples.

-Australian banks have been outperforming the index
-Earnings forecasts lower across FY24-25
-PE multiples have expanded
-Bad debts have surprised positively

By Greg Peel

Bank share prices have continued to rally in recent months, Macquarie notes, despite broadly consistent negative consensus views amongst investors and sell-side analysts (stockbrokers).

To that point, of seven brokers either monitored daily or regularly by FNArena, six have Sell or equivalent ratings on Commonwealth Bank ((CBA)) – some recent downgrades and other longstanding – while only one has a Hold rating. CBA’s share price has nonetheless hit all-time highs.

Banks are looking expensive in absolute and relative terms, Macquarie suggests, after some 6% relative outperformance versus the broader market in the second half of 2023 and a further 8% since the beginning of this year.

The analysts thus pose the question: what are we missing?

Bank earnings expectations are more reasonable now, Macquarie suggests, but not overly conservative. The broker sees potential upside risk to earnings from rates remaining at current levels for longer while the economy remains resilient.

However, should rate cuts come through as expected, which is arguably the key driver of higher valuations in recent months, Macquarie sees downside risk to earnings, believing it will be difficult for banks to offset margin headwinds associated with lower rates.

Given the current political landscape and increased focus on social aspects, Macquarie thinks it will be difficult for banks to reprice mortgages, particularly in an election year (2025).

The broker sees limited scope for banks to materially surprise the market in the medium term and hence sees limited fundamental reasons for a structural re-rating. While accepting a lower risk profile for the sector, Macquarie believes it comes at the cost of lower margins and returns over the medium term.

Macquarie’s response? “Underweight everything”. The broker has downgraded all of Westpac ((WBC)), ANZ Bank ((ANZ)) and National Bank ((NAB)) to Underweight, joining CBA. Westpac suffered a double-downgrade from Outperform, while the other two are down from Neutral.

Not Alone

UBS goes a step further in noting bank share prices have rallied over 20% since November which the broker suggests has been driven by a soft-landing scenario, implying lower expected credit losses, and signs of lessening competitive pressures in deposits and lending.

Yet consensus currently has bank earnings declining by -8% in FY24 and -3% in FY25, and PE multiples have expanded to 16.1x forward during this period from 13.2x, UBS notes.