Tag Archives: Banks

article 3 months old

Link Delivers On Targets Yet Upside Elusive

Funds administrator Link Administration has delivered on its integration targets yet several brokers suspect upside is factored into the stock.

-Expects to return group operating earnings margins to 34% by FY20
-Near-term headwinds for recurring revenue suggests better buying opportunity ahead
-Risks from competitive pressures which may erode margin expansion


By Eva Brocklehurst

Market services and funds administrator Link Administration Holdings ((LNK)) has delivered on its Superpartners integration targets in the first half of FY17, ahead of time and budget. Brokers expect these synergies will continue to materialise through FY18 and FY19.

The company posted results ahead of market expectations and materially stronger than the previous corresponding half, and expects to progressively return group operating earnings (EBITDA) margins to 34% by FY20. Yet, several broker consider this upside is already factored into the stock.

In Macquarie's view the main issues for Link remain revenue growth, margin progression and the movement in provision balances. Link utilised $24.5m in provisions in the first half and reversed $2.9m in other provisions via significant items. For the company to achieve Macquarie's earnings expectations, these costs will need to be removed.

Macquarie forecasts 1-3% revenue growth from FY17-20 and likes the fact that new business continues to bolster recurring revenue in an competitive environment. While pricing remains under pressure this is offset by increased volume, the broker notes. Macquarie retains an Outperform rating.

A tougher corporate market is eroding the medium-term margin upside, UBS believes. Hence, the broker envisages only moderate upside to the stock, calculating longer-term growth in earnings per share of 3-4% per annum and lifting this to 6% per annum when potential capital management accretion is included.

Better Buying Opportunity Ahead

The broker's Neutral rating is retained. Funds administration margin expansion particularly impressed UBS, as it lifted to 22.0% compared with estimates of 18.0%.

Citi finds the share price becoming more attractive yet, with some near-term headwinds for recurring revenues in funds administration, suspects there may be a better opportunity ahead. Citi also retains a Neutral call. Substantial earnings growth is intact, driven by the recovery in margins as Superpartners synergies are realised.

In the near term, nevertheless, there are revenue growth pressures for funds administration, as the fee reduction for Superpartners appears reasonably significant. The company's corporate markets division won a number of clients during the half but margins fell to 23% from 28%, likely in Citi's view to be partly caused by the drop in non-recurring revenue that was flagged for this division after a robust performance in the previous corresponding half.

Funds administration produced greater revenue growth than Morgans expected, while the corporate market revealed margin compression, which remains a concern. The broker likes the stock and believes it has a strong competitive position and should benefit from favourable longer-term structural tailwinds. Morgans forecasts double-digit growth in earnings per share per annum over the next four years.

The risk lies with competitive pressures, which may erode the margin expansion from the Superpartners synergies. The broker believes the current valuation is fair as opposed to offering significant value and maintains a Hold rating. Upside risks are likely to come from further client wins in funds administration, stronger EBITDA margins in corporate markets, and faster and larger synergies extracted from the Superpartners integration. Downside risk come from greater competition.

Acquisition-led Growth?

Citi notes, at the IPO, one of the company's attractions that was highlighted, beyond the margin expansion from Superpartners synergies, was the opportunity to grow market share in funds administration, given its significantly cheaper cost of administration.

The unease expressed by the competition regulator, ACCC, regarding the bid for Pillar late last year has caused the broker to query such acquisitions as a means to growth. The company remains upbeat about the medium-term opportunities, suggesting that it was hard to pursue other meaningful contracts while attention was focused on the Superpartners integration.

Regardless, while Citi is optimistic about Link's ability to win new contracts over time, the lead time required for bringing funds on board and converting these to revenue suggests this is more likely to be a medium term rather than the short term feature for revenue growth.

FNArena's database shows one Buy rating (Macquarie) and four Hold. The consensus target is $8.29, suggesting 10.7% upside to the last share price. Targets range from $8.10 (UBS) to $8.50 (Macquarie).

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article 3 months old

Will Challenger Require More Equity?

Wealth manager Challenger's first half results mark a shift to longer duration annuities and brokers mull whether the company requires more equity.

-Reduction in the capital position of the life business considered the main negative
-New business strain may require more capital, or more growth assets
-Peak passed in maturities, increasing proportion of longer-term annuities

By Eva Brocklehurst

Wealth manager Challenger's ((CGF)) first half result marks a shift to longer duration annuities, supported by the company's new relationship with Mitsui Sumitomo Primary Life to sell Australian dollar-denominated securities in Japan, amid the company's expanding distribution partnerships domestically. Guidance for cash operating earnings (COE) in life has been re-affirmed for FY17 in a range of $620-640m.

Nevertheless, while positive for growth in assets under management, spread margins and profits, this also comes with a capital cost, the size of which is unclear to UBS. The company is expected to maintain its dividend pay-out ratio and this, along with rising asset risk charges, may require future injections of equity to fund growth, constraining value upside.

As a result, UBS maintains a Neutral rating. First half normalised net profit of $197m was 2.7% ahead of the broker's estimates, the beat entirely due to funds management which enjoyed strong flows and a post-Brexit UK revenue rebound.

Concerns Over Capital Intensity

The company's tier one capital ratio fell to 1.02 in the half, close to the 1.0 level UBS envisages as a minimum. At current capital intensity the company requires $225 in CET1 (1.0), and with new business strain from longer-term annuity growth the gap is likely to widen over the next 2-3 years, in the broker's opinion.

Macquarie suggests the company has a number of levers to support growth in its life investment assets, as well as continuing to invest in the funds management division, before the growth rate will require additional equity capital. Furthermore, the broker does not expect the company will push capital to the limit, noting the regulator assesses capital on a medium-term view.

Given a focus on earnings per share and returns, Macquarie expects the company to use at least some of its levers to manage its capital position before adding more equity to support growth beyond 18-24 months.

Unchanged FY17 guidance surprised Ord Minnett, although this probably reflected some modest pressure on margins. The broker also did not expect the sharp deterioration in capital coverage. The growth story in FY18 could offer some reasonable upside, the broker acknowledges, while those worried about risks could point to margin declines and the reduction in capital coverage.

Ord Minnett also recognises Challenger has levers to alleviate any tightness in its capital position but believes spread profits are reasonably volatile and a higher discount rate is needed to reflect the risk, including the risk of forced liquidation in stressed scenarios.

The broker notes new business strain may limit normalised growth to around 7.5% per annum in the absence of external capital funding initiatives. Nevertheless, Ord Minnett's main concern is with valuation, which leads to a Lighten rating. Another potential risk on the horizon is that the Australian government may adversely change the social security effectiveness of annuities for policy holders, as it is currently undertaking a review.

Fully valued?

The noticeably weaker capital metrics took the gloss off an otherwise solid result, in Morgan Stanley's view. The broker believes, with the peak of rising maturities now behind the business and the tenor of new business increasing, Challenger no longer needs "record" sales to drive growth in its book. The stock is not cheap and, while maturities have peaked, Morgan Stanley notes product margins are soft.

Credit Suisse believes margin contraction is overplayed and having absorbed interest-rate reductions, the company is in a good position to address any concerns around margin pressure. The broker also highlights that the company has the ability to fund over 20% growth in its net book in a single year before it would require additional equity.

The first half result confirms the broker's view that volatility in its capital position is not well understood by the market. Because of lumpiness in asset purchases and sales in the company's property asset class, capital intensity can move around from half-year to half-year.

While the capital position appears soft, after the debt raisings - Credit Suisse expects multiple - the issue is expected to be addressed. Credit Suisse is confident earnings growth will come through, noting expectations were high going into the results.

Citi simply considers the stock expensive and retains a Sell rating. While the relationship with Mitsui Sumitomo has started on a strong note, the broker's analysis suggests momentum is slowing elsewhere, although acknowledges this may reflect the company becoming more discerning about where it allocates capital, or it may indicate that capital is now being rationed. Over time Citi believes this should be good for book growth and margins.

Regulatory and industry tailwinds remain positive for the medium to longer term and maturities should also decline in later periods, suggesting to the broker more of the sales growth could turn into earnings growth.

Morgans also likes the story for the longer term and believes an excellent job has been done opening up growth opportunities for the business. Average new annuity tenor improved to 8.7 years, with longer term annuities now representing 31% of total sales compared with the prior corresponding half at just 14%. Nevertheless, as the stock has re-rated strongly over the past 12 months, the broker considers fully valued.

FNArena's database shows two Buy ratings, four Hold and two Sell. The consensus target is $10.69, suggesting -7.0% downside to the last share price. Targets range from $8.75 (Deutsche Bank, yet to update on the result) to $12.34 (Macquarie).

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article 3 months old

Stellar Growth For Blue Sky Alternative

Confidence in the near-term prospects for Blue Sky Alternative Investments is supported by strong growth in institutional clients.

-Targeted assets under management increased to $3.1-3.3bn for FY17
-Despite fee compression, expected to leverage cost base and expand margins
-Further strength in the share price expected, although volatility anticipated


By Eva Brocklehurst

Blue Sky Alternative Investments ((BLA)) produced a stellar first half, driven by institutional investment across several classes. Confidence in the near-term growth prospects for growth assets under management (AUM) is supported by existing mandates, with the company offering an attractive proposition for institutional clients.

The business is still relatively immature but Morgans believes, despite this, it is delivering on some ambitious targets. Management/transaction fee growth of 37% lagged growth in average AUM of 57%, probably because institutional fees increased to 37% of the base from 11% in the prior corresponding half.

Management fees also fell versus the second half of FY16, which Morgans believes was mostly driven by the type of deal transacted over the half year. Performance fees were up 13% and the broker estimates $6m in cash was realised from prior performance fees in the half year.

Management has clear visibility on its outlook, based on deal flow and current mandates, and has increased its targeted AUM for FY17 to $3.1-3.3bn. Morgans expects growth in institutional AUM to continue to outpace retail/wholesale growth in the near term. This is leading to further fee compression but the company can leverage its cost base and achieve margin expansion over FY17-19. The broker's price target is $8.50 with an Add rating.

After factoring in a lower revenue margin, option issue and higher costs, Ord Minnett downgrades FY17 and FY18 forecasts for earnings per share by 6% and 7% respectively. The broker upgrades FY19 forecast for AUM to $4.8bn, closer to the company's target of $5bn.

Management Fee Margin May Fall

The broker notes the implied management fee margin for the half year was 23 basis points lower than the prior corresponding half because of higher institutional money in the mix and also because of the recognition of the company's 38% interest in the New York property venture, Cove, for which management fees are not recognised in the accounts.

Ord Minnett concurs that management fee margins may come down as the institutional mix increases but operating leveraged should provide continued profit growth and expansion of the earnings margin. The broker upgrades to Buy from Hold, noting the stock is trading on a price/earnings ratio for FY18, ex cash and investments, of 14.4x and is growing earnings per share by around 40%. The broker's target is $7.87.

Canaccord Genuity believes the company is in a sound position to deliver on FY17 guidance for net profit of $24-26m. The broker takes into account some decline in reported margins but acknowledges higher levels of AUM, which are up $1bn over the past 12 months.

In terms of performance fees, the broker notes these tend to be skewed to the second half, where valuations are more prevalent leading into the end of the financial year and the deal flow is greater. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $9.45 target.

Despite marginally missing estimates for the half year, Shaw and Partners retains a bullish view. The main aspect for the broker was the upgraded guidance in AUM. Performance fees of $9.3m exceeded the broker's expectations.

Although absolute returns have been down on historical levels, the broker believes investors need to be aware that performance fees are generated on an asset-by-asset basis, which differs with a typical asset management business, which generates fees at the fund level,

The broker notes the company invests in a number of income assets with risk/return profiles which are different to that of private equity investments, hence the 10-year track record of 16.4% masks a divergence in the performance of underlying assets.

Long-term performance across the units is still at lofty levels, although private equity returns have been relatively subdued while the private real estate business remains hot. Shaw and Partners believes the current share prices further to run although volatility is anticipated along the way. The broker, not one of the eight monitored on the database, retains a Buy rating and $10 target.

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article 3 months old

NAB Dividends Likely Safe

National Australia Bank's first quarter update held few surprises. Revenue growth was subdued and brokers are mindful of the challenges in maintaining the dividend pay-out.

-Provisioning at lowest level in 12 months as mining, agricultural risk exposure eases
-Cost growth outstripping pace of revenue growth, despite higher financial market income
-Long-term value envisaged as business credit growth shows signs of improvement


By Eva Brocklehurst

National Australia Bank ((NAB)) delivered a first quarter update that held few surprises for brokers. The bank posted $1.6bn in quarterly cash earnings. Revenue growth was subdued, up 1%. Underlying margins were stable, as competition for deposits eased, while trading revenues were strong on the back of high levels of volatility. Provisioning improved relative to the second half of FY16.

Provisioning was that its lowest quarterly level in 12 months, $80m below Ord Minnett's expectations, given the non-repeating overlay for mining and agricultural exposure. The broker expects a typical seasonal uplift in the second quarter for provisioning. Elevated expenses growth of 5% is expected to improve over the year from efficiency initiatives, which should mean there is sufficient capital generated to maintain a flat dividend at an 80% pay-out ratio, in the broker's view.

Net interest margin was broadly stable in the first quarter following a decline of 11 basis points over the second half of FY16. The flat margin in the first quarter suggests to Ord Minnett that the recent re-pricing of selective mortgage products is offsetting the flowing through of higher deposit costs.

Credit Suisse was slightly disappointed with the update and believes it sets a subdued tone for the bank reporting season. The broker did not like the fact that costs growth is outstripping the pace of revenue growth, even though revenues benefitted from higher financial markets income. The broker believes banks are facing a difficult underlying profit environment, despite asset quality metrics remaining stable amid modest consumption of capital.

Dividend Should Be Maintained For Now

The stock offers some credit quality and good cost discipline in Morgan Stanley's view, but an improvement in revenue growth is needed to drive upgrades to earnings-per-share estimates. The broker does not expect housing and business loan growth to surprise on the positive side and, with margins still under pressure, now factors in subdued revenue growth of around 2% for FY17.

The broker assumes a further 10 basis points of re-pricing across the mortgage portfolio but believes this is increasingly likely to be skewed towards investment property loans. Morgan Stanley also expects a flat dividend outcome. Consensus assumes FY17 profit of around $6.6bn and the broker believes this will be a challenge, unless loan losses stay under 15 basis points or revenue growth improves.

The outlook is more positive in Macquarie's opinion, with mortgage re-pricing benefits, a more rational competitive environment and productivity benefits supporting earnings growth, and an elevated dividend is likely to be supported in the near term, especially while capital rules are being finalised. The broker continues to envisage longer-term value for the stock, particularly as business credit growth shows signs of improvement.

Morgans observes the bank continued to run off below-returning institutional exposures over this first quarter and this would have weighed on loan growth. It would also explain why the bank's Australian loan growth was well below system loan growth, despite its home loan growth being just slightly below system.

The broker's base case is that the bank will keep its nominal dividend flat for FY17 but suspects it will be reduced this year, as NAB is seen as having the most stretched dividend pay-out ratio relative to returns on tangible equity of all the major banks. Over time, the bank is aiming to reduce its dividend pay-out ratio to within its long-term range of 70-75%.

Stock Screens Cheaply

CLSA believes that the stock, having consistently performed below its peers, now trades cheaply and there is scope for it to positively re-rate. The bank remains the broker's favoured stock among the major banks. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has an Outperform rating and $33.82 target.

Deutsche Bank was pleased with the update, as there were few surprises compared with updates of the past. While the broker believes this justifies a further re-rating versus peers, it concedes the operating environment is challenging, with revenue growth low despite a flat net interest margin. Nevertheless, with the stock looking inexpensive, and the tilt towards small business banking likely to deliver better net interest margin, the broker retains a Buy rating.

UBS is more cautious, believing the bank is progressing with its turnaround but, given the rally in recent months, the broker remains on the sidelines with a Neutral rating. UBS believes the improvement in impairments in the quarter is a "catch up" to the other banks. While asset quality trends remain broadly stable, the broker expects charges will inevitably rise from current levels throughout the year.

There are three Buy ratings, four Hold and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $30.85, signalling 0.8% upside to the last share price. Targets range from $28.50 (Morgan Stanley) to $34.50 (Credit Suisse).

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article 3 months old

Solid Outlook Prevails For Credit Corp

Brokers flag a solid outlook for debt purchaser and consumer lending business, Credit Corp.

-Record level of debt purchasing in the first half
-Loss of market share considered only minor
-Double-digit earnings growth expected over FY18-19


By Eva Brocklehurst

Debt ledger purchaser and consumer lending business Credit Corp ((CCP)) has proved its consistency in the first half. Growth divisions are on track, consumer lending should hit pro-forma returns and the US division is expected to become profitable in the second half.

The company has confirmed FY17 earnings guidance for profit of $53-55m, which would represent 15-20% growth on FY16. Forward flow tenders awarded late in FY16 and the secondary market purchase of NCML's ledger book underpinned a record level of debt purchasing (PDL) in the first half.

Canaccord Genuity suggests investors may have been confused by commentary that signalled market share losses occurred, relating to the unsuccessful renewal of some forward flows. While pricing has improved on some of the larger forward flows, where capital requirements limit competition, some of the smaller business has been aggressively bid away by peers, the broker suspects.

This raises one of the questions frequently put to the broker, as to whether the company is close to reaching a ceiling in terms of market share. The loss of some market share in the half year is suspected to be unfairly interpreted as proof that this is the case. The broker asserts that losing out on a handful of small tenders, as others have opted to bid more than the most efficient operator in the market is prepared to pay, should be a comfort to investors.

Earnings guidance has been maintained, while the company's purchasing for the year is locked in, and there should be limited downside to the full-year result. The broker suggests, if competitors over-reach on price, there will be a benefit from reduced purchasing competition and returns should improve going forward.

Pricing Discipline Maintained

Hence, the company's willingness to maintain pricing discipline in recent weeks should mean free cash flow is generated over the next six months, leaving it well placed to capitalise on pricing improvements and any fall-out in the industry. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $19.23 target.

Adjusted operating earnings growth of 15.2% was in line with Morgans' forecast, driven by 13.5% growth in cash collections, lending interest revenue, and a slight improvement in the operating margin, to 58.5%.

A second half earnings uplift is expected to be driven by the lending division, which will benefit from seasonally lower volumes and lower planned marketing expenditure. Morgans also expects a meaningful uplift in cash collections, which provides confidence the company is tracking towards the top end of guidance.

Morgans expects solid double-digit organic earnings growth over FY18-19. While stock is trading at the top end of its longer term price/earnings ratio, at around 14.8, the broker believes the premium can be sustained, because of the growth profile and track record. Morgans retains an Add rating and $19.90 target.

Profit Guidance Easily Attainable

Ord Minnett retains an Accumulate rating on the stock, with an $18 target. The broker expects profit guidance to be relatively easily attained, given the committed pipeline of PDL acquisitions, the increased head count and a seasonal pause in consumer lending growth. While gearing is elevated, at its highest level since FY09, management has highlighted a significant increase in operating cash flow is expected in the second half.

To fund the medium-term growth aspirations, management has signalled it is actively exploring extending existing finance arrangements as well as asset-backed financing options. Ord Minnett remains cautious on the outlook for the US business, but expects further regulatory clarity over the next six months. Moreover, the upside remains a relatively cheap option for shareholders, in the broker's opinion.

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article 3 months old

Australian Banks: Valuations Stretched

Bank analysts all agree there is limited upside for Australian bank share prices since their recent re-rating.

- Subdued earnings outlook remains
- Picture at least brighter than 2016
- Capital raising risk has eased
- Consensus suggests limited upside


By Greg Peel

Remember the GFC? It was over eight years ago. In the wake of public bail-outs of “too big to fail” banks across the globe (but not in Australia, beyond a temporary deposit guarantee), the international bank regulator based in Basel decided banks deemed “too big to fail” must carry more capital as an offset to systemic risk.

How much capital? The Basel Committee sat down and started to figure that out. After eight years, and no doubt a sigh of relief there hasn’t been another GFC in the meantime, the Basel IV regulation updates were expected to be made known by around about now. But the news from Switzerland is committee members are struggling to find common ground. Hence Basel IV has been delayed. The committee has only had eight years to think about it.

We nearly did have another GFC, around this time last year. While US banks acted swiftly, post bail-outs, to rebuild their balance sheets, European banks did not. By this time last year, shares in European banks were sliding dangerously. And not just the shares of small Italian banks – when Deutsche Bank was hit with a massive US fine (also GFC-related, seven years on), there was a very real risk the one-time German leviathan would become insolvent. Switzerland’s iconic banks were also looking shaky.

Australian banks entered 2016 with a dire backdrop for the global banking sector. Adding insult to injury at a local level were tumbling commodity prices, a slowing Chinese economy, and an ambiguous suggestion from the local regulator, APRA, that the balance sheets of Australian banks will be required to be “unquestionably strong”. This suggested Australia’s big banks would need to carry even more capital than Basel IV levels, and thus threatened a very real risk of further capital raising requirement.

Just when it couldn’t get any worse, some local ‘big name” companies were hitting the wall, the New Zealand dairy industry was in crisis, and the economies of the Australian mining states were in a tailspin thanks to the end of the mining investment boom and the collapse of key commodity prices. After seven years of winding back GFC bad debt provisions and handing out those reserves as dividends, suddenly it looked if Australian banks may have to quickly top up provisions once more.

After flying so high on the “global search for yield” in the years leading up to 2016, Australian banks share prices were being trashed. To put things into perspective, Commonwealth Bank ((CBA)) opened the year on $85 (having seen $95 in 2015) and dropped to under $70 in August.

August represented the bottom in commodity prices. Earlier in the year, US regulators decided to reduce the fine they had imposed on Deutsche Bank. The second half of the year failed to produce any more “big name” defaults as had been the case in the first half. APRA eased back on its tough talk of earlier in the year, and while introducing housing investment loan restrictions, managed to ease fears of significant bank capital requirements. The banks, loaded up with mortgages, took advantage of further RBA rate cuts to “reprice” their mortgage books, meaning not passing on the full amount. Bank share prices consolidated.

Then in November, along came The Donald. The immediate response was a surge in US bond rates and a surge in the share prices of US banks. Trump would return the US to solid economic growth and that would be good for all the world. Bank shares rallied across the globe, including in Australia.

Commonwealth Bank is today trading at $85.

Australia is not the US

While significant, the share price recovery post US election for Australian banks has not been quite as spectacular as the rallies in the US and Europe. And with good reason.

Banks typically benefit from higher interest rates, as higher interest rates allow for wider spreads between borrowing rates and lending rates (net interest margin). Trump’s campaign promises have led to a “reflation” trade in the US on the prospect of better economic growth, sending interest rates rising and US banks shares rising in tow. However, higher interest rates are not necessarily a good thing for Australian banks right now.

Australia’s 26-year run of economic growth has led, notes UBS, to significant household leverage and inflated housing prices. The housing boom has the RBA worried. Would rising interest rates potentially trigger cascading mortgage defaults?

The good news on this front is there’s no sign of the RBA hiking rates anytime soon. But that same good news limits the opportunity for Australian banks to increase their net interest margins. The Australian economy may not have known an official recession since the nineties but there is little doubt pockets of recession have featured in various sectors. The rebound in commodity prices have been a saviour for the economy but we are not about to see another mining investment boom to the extent we did in the noughties. The housing sector has carried the can in recent years but will shortly cool.

The reality is a Trump-driven US economic recovery, if that is what is about to transpire, will not flow through significantly to Australia. This is particularly the case if Trump makes good on his protectionist threats. Australia is its own economy – hamstrung by fiscal stasis, at the mercy of the Chinese economy, and overly indebted at the household level.

So Australian banks are not about to shoot the lights out in 2017. Analysts agree that 2017 will be better than 2016, but not spectacularly so.

Remaining Subdued

Deutsche Bank’s analysts are forecasting an average of 2% earnings growth for the banking sector in FY17. That’s “relatively modest,” Deutsche notes, but it’s a lot better than the FY16 outcome of a -3% earnings decrease.

UBS has this week upgraded its earnings forecasts, but warns the “subdued medium term outlook remains”. Macquarie agrees the outlook has improved, but slow growth environment will likely only deliver low single digit earnings growth.

Macquarie believes the easing of competitive pressures between the banks for loans and deposits will mean net interest margins should be at least stable or may rise above consensus expectations. Morgan Stanley acknowledges an easing of competition, but believes margins will remain under modest pressure.

The bottom line is Australian households and businesses are not about to rush out and borrow heavily in 2017. Households are already up to their eyeballs and despite low rates, the economic environment is not sufficiently inspiring for businesses. In the meantime, the banks are currently undertaking what Citi describes as a one-in-thirty year IT upgrade phase which is elevating costs at a time revenues are limited.

A brighter picture nonetheless

One of the biggest concerns of 2016 was the likely need for the Big Banks to raise new capital, again, to satisfy global and local regulations. While there was disagreement among bank analysts throughout 2016 as to whether, and to what extent, fresh raisings would be necessary, all now agree the immediate threat has eased.

As to how long it will take the Basel Committee to agree on new capital requirements is anyone’s guess but given the delay, and the fact the committee has itself played down the potential harshness of new requirements, there is a greater possibility Australian banks can get by on organic capital growth and dividend reinvestment plans. And there’s always the possibility of further non-core divestments, such as selling off wealth management and life insurance divisions.

There remains the question of just what is meant by “unquestionably strong”, but APRA, too, has moved to allay fears. The regulator has suggested 2017 will be a year of consultation, suggesting no new requirements will be imposed before talking it through with the banks. Even then, the banks will be given plenty of time to comply. APRA can’t impose a capital buffer requirement over Basel regulations until the Basel regulations are known.

Another feature of 2016 was collapsing commodity prices, which threatened defaults on loans to the mining sector right through to defaults on the mortgages of former mineworkers. While many had decided by August commodity prices had likely bottomed, no one foresaw the strength of the rebound. Strike that particular risk off the list for now.

There still remain “pockets of weakness” in the Australian and New Zealand economies but these are not significant, and while the Dick Smiths of the world seemed to be dropping like flies early last year, it appears we just saw a coincidental blip in “big name” defaults rather than a trend. Bank analysts have factored in a cyclical rebound in bad & doubtful debts, but suggest earnings upside is a possibility if such assumptions prove too aggressive.

There also remains the possibility of earnings upside if the banks were further to “reprice” their mortgage books. A lot will depend on the RBA, and here the picture for the official cash rate has never been murkier.

On the one hand, we had the scare of the Australian economy suffering negative growth in the September quarter, following the scare of disinflation earlier in the year. We have also had, for a long time, expectations Australia’s unemployment rate must rise. But on the other hand, the recovery in commodity prices has eased fears on both counts.

Some, but not all, economists still expect the RBA will need to cut further. There is at least agreement that if the next move is up, it won’t be this year. A lot will depend on global rates, specifically the US, and thus the Trump effect. If the RBA does cut, another opportunity is provided for the banks to reprice mortgages.

So the upshot is risks have diminished for the banking sector, there may be upside opportunities, but the likely outcome is still a subdued credit growth environment in 2017. So where does that leave bank share price valuations?

All in the price

While the recovery in Australian bank share prices has not been quite as spectacular as those of offshore peers, it’s been a solid run nevertheless. At the very least, the valuation gap to the industrials sector, which had yawned at the depths last year, has all but been closed.

We have also seen a bit of a pullback from the highs in recent sessions, likely because one by one bank analysts have come out with reports suggesting the banks are now at least at fair value, all things considered, or overvalued given the outlook.

Macquarie pulled its sector view back to Neutral. UBS is currently maintaining a “relatively neutral view”. Deutsche suggests the brighter outlook is “largely in the price”. Morgan Stanley notes Australian bank valuation metrics look elevated compared to history. Last week Citi declared quite boldly “sun to set on bank share price rally”.

Shaw & Partners, not an FNArena database broker, has told institutional investors and short-term traders it’s time to sell, while long term investors should just ride it out. In other words, long term investors should not buy the banks unless lower share prices are on offer.

The recommendations and forecasts of the eight major brokers in the FNArena database are tabled below.

The first point of note is that CBA and National Bank ((NAB)) have exceeded consensus targets (based on yesterday’s closing prices). Westpac ((WBC)) and ANZ Bank ((ANZ)) are not far off. History shows that whenever targets are exceeded, a share price pullback follows unless analysts are given cause to upgrade their forecasts.

Judging by consensus of a subdued earnings outlook, the latter seems unlikely the case in the near term.

We also note a total of ten Buy (or equivalent) ratings, eighteen Hold and four Sell. While the number of Hold ratings is consistent with a general view of fair to overvaluation, ten Buys to four Sells appears contradictory, and indeed is not a lot different to the 13/17/2 Buy/Hold/Sell split in place in September last year (following bank reporting season). There are three points to note here.

Firstly, these are individual bank recommendations, relative to the sector. Secondly, analysts are always disinclined to offer Sell ratings given it upsets the company they are rating and potentially leads to limited access to management. Thirdly, stock brokers do not make money by encouraging investors to sell.

Next month will provide the opportunity for bank analysts to update their forecasts. CBA will report first half FY17 earnings while Westpac, NAB and ANZ will update on first quarter FY17 performance.

Technical limitations

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article 3 months old

Bendelaide Hits A Brick Wall

By Michael Gable 

Donald Trump is now President of the US and the sun still rose the next day. Reporting season kicks off in a few weeks time and as the market eases back into that time frame, it will once again throw up a few opportunities. It also becomes a minefield of earnings misses and yesterday saw downgrades from real estate company McGrath (no surprises there) and Brambles (surprised everyone, and "embarrassed" the outgoing CEO). Gold continues to march on and smaller cyclical stocks continue to rally such as LNG Ltd and BlueScope which traders took profits on yesterday.

Over the last few weeks, we have been flagging short-term weakness in the S&P/ASX 200 Index and for that to be mainly driven by the banks - which is precisely what is happening. The big 4 get a lot of coverage but in today's report we look at the charts of Bendigo and Adelaide Bank (BEN).

After an impressive run last year, BEN seems to have hit a brick wall. Like the other banks, it is expected to come back here. It has provided us with some reversals signals (circled), the shooting star on the price chart and a sell on the RSI. BEN is expected to now pull back towards support near $12, but ultimately we believe it can go as low as about $11.30.

Content included in this article is not by association the view of FNArena (see our disclaimer).
Michael Gable is managing Director of  Fairmont Equities (www.fairmontequities.com)

Michael assists investors to achieve their goals by providing advice ranging from short term trading to longer term portfolio management, deals in all ASX listed securities and specialises in covered call writing to help long term investors protect their share portfolios and generate additional income.

Michael is RG146 Accredited and holds the following formal qualifications:

• Bachelor of Engineering, Hons. (University of Sydney) 
• Bachelor of Commerce (University of Sydney) 
• Diploma of Mortgage Lending (Finsia) 
• Diploma of Financial Services [Financial Planning] (Finsia) 
• Completion of ASX Accredited Derivatives Adviser Levels 1 & 2


Michael Gable is an Authorised Representative (No. 376892) and Fairmont Equities Pty Ltd is a Corporate Authorised Representative (No. 444397) of Novus Capital Limited (AFS Licence No. 238168). The information contained in this report is general information only and is copy write to Fairmont Equities. Fairmont Equities reserves all intellectual property rights. This report should not be interpreted as one that provides personal financial or investment advice. Any examples presented are for illustration purposes only. Past performance is not a reliable indicator of future performance. No person, persons or organisation should invest monies or take action on the reliance of the material contained in this report, but instead should satisfy themselves independently (whether by expert advice or others) of the appropriateness of any such action. Fairmont Equities, it directors and/or officers accept no responsibility for the accuracy, completeness or timeliness of the information contained in the report.

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article 3 months old

ANZ Bank Shares Targeting $32

Bottom Line

    Daily Trend: Up
    Weekly Trend: Up
    Monthly Trend: Up
    Support Levels: $25.78 / $21.86
    Resistance Levels:  $31.37/ $32.00 / $37.25

Technical Discussion

    ANZ Bank ((ANZ)) is one of Australia's "Big 4" offering a range of banking and financial products to retail, corporate and institutional clients. Whilst ANZ is best known in Australia and New Zealand, it has a significant business in Asia. In July 2014, the company completed the sale of ANZ Trustees Ltd to Equity Trustees Ltd. For the six months ending the 31st of March 2016 interest income decreased 2% to A$15.09B. Net interest income after loan loss provision increased less than 1% to A$6.66B. Net income applicable to common shareholders decreased 22% to A$2.74B. Broker/Analyst consensus is currently “Hold”.  The company pays a dividend of 5.4%.
    Reasons to be more optimistic:
    → Improved credit quality and steady revenue trends.
    → Restructuring remains a focus.
    → The mortgage pricing war appears to have eased with discounting reduced.
    → There are still question marks regarding the dividend being maintainable.
    → Management focusing on returns as opposed to growth.
    → The company has re-priced investor loans by eight basis points.

    The banks have been looking much better over the past few months with price breaking higher out of a large triangle basing pattern on this particular chart. Indeed, the same pattern is evident on the chart of CBA. It is worth reiterating that extremely large consolidation patterns like the one shown here can just as easily prove to be reversal setups although textbooks will tell you otherwise. We must also take into account the fact that the recent low completed almost exactly at the 61.8% retracement zone of the prior leg higher. This again adds weight to the more bullish case. Either way, we couldn’t have asked for anything more with price breaking higher out of the small pennant we were focusing on back in November. Our initial target was the typical retracement zone which is exactly where price currently sits. However, we had a higher target zone in place which incorporated the measured move out of the triangle. We still believe those higher levels will be achieved next year. Technically, there is bearish divergence in place on both the daily and weekly charts although it’s now the less significant Type-B variant. Should price continue higher over the next couple of days then the divergence is unlikely to be significant which of course would be the ideal situation. Zooming into the more recent price action shows that today price broke higher out of a small pennant that could well be that target area is going to come under pressure sooner rather than later. We must keep our feet firmly on the ground over the longer term but for the moment we couldn’t ask for anything more with impulsive price action starting to show.

Trading Strategy

    “…The strategy is to buy following a push through the upper boundary of the pattern meaning a break above today’s high at $28.07 would be reason to jump on. The initial stop should be placed just beneath last Thursday’s low at $27.01…”  We currently hold long positions at $28.08 but although price is heading in our favour, we’ll leave our initial stop in place for the moment to allow room to breathe. We’ll also continue to run with a trailing stop as opposed to a set target, although as mentioned last time there is scope to head up toward the measured move out of the triangle around $32.00 which is an area where we’ll be looking to reduce risk. If you aren’t already involved it’s best to stand aside for the moment.
    Disclosure: Nick Radge holds

Re-published with permission of the publisher. www.thechartist.com.au All copyright remains with the publisher. The above views expressed are not by association FNArena's (see our disclaimer).

Risk Disclosure Statement


Technical limitations If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.

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article 3 months old

Brokers Question IAG’s Change In Tack

Insurance Australia Group's is shift to a more customer-centric model has brokers highlighting the risks.

-Targets suggest 10% growth in earnings per share
-Investors cautioned about using cost savings as basis of profit growth
-Customer loyalty may be tested by changes to the system


By Eva Brocklehurst

Insurance Australia Group ((IAG)) has signalled a shift away from a strategy of acquiring growth, one that has been in place since listing in 2000.

The company has implied around 10% growth in earnings per share per annum for the next four years and provided 3-5 year growth and earnings targets. The commitments are largely based on achieving gross written premium (GWP) growth targets and delivering $250m in operational savings in FY20.

Market-related organic GWP growth and reductions in expenses are expected to provide the operating base for future earnings growth, UBS observes. On both measures, the broker asserts the company has fallen short in recent years. Hence, this is uncharted territory for IAG.

The broker is encouraged by the progress being made so far in terms of innovation and customer initiatives but remains conservative in its forecasts. Customer-led initiatives and innovation, while not insignificant, are less tangible and, therefore, in its assessment UBS focuses on efficiencies.

Cost savings are expected to flow across claims handling, underwriting expenses and fee businesses, and appear credible. The broker gives the company the benefit of the doubt and reduces the forecast expense growth trajectory beyond FY19. UBS also notes there is minimal headroom for another buy-back in 2017.

Credit Suisse does not believe the targets will be achieved. Moreover, they will be, realistically, difficult to measure in five years time. While the broker is encouraged by a focus on costs, investors are cautioned around using cost savings as a basis of profit growth. The broker asserts cost saving programs are more an acknowledgement that the environment is tough.

That said, Credit Suisse is not suggesting the company's new focus on customers is heading for failure and highlights the fact such a strategy has been in place for over five years and, arguably, the company should understand the potential much better now. Hence, the opportunity may be greater.

The concern the broker has is with new products and the potential to upset the existing customer base. In essence, innovation and embracing change are worthwhile but do not come without risk, especially if you are the largest player in a stale industry.

While the company's growth has been 1-2% below system in recent years, its retention rate for personal lines remains one of the highest in the world and the broker asserts that disturbing a loyal and profitable back book is a key risk.

In a challenging insurance market, Credit Suisse does not believe the peak multiple to be justified either. The stock is currently trading at the highest absolute price/earnings ratio it has traded at since listing, at 16.4x. This is well above the company's historical 10-20% discount. The broker retains an Underperform rating.

The cost optimisation program is larger than Morgans expected. The scale has exceeded the combined $230m in benefits derived from the synergies from the Wesfarmers ((WES)) insurance business acquisition and the implementation of a new operating model.

The target of 10% compound growth in earnings per share implies further capital management, in the broker's view, and evidence supports the prospect of some being implemented in FY18.

While Morgans retains some scepticism regarding the sustainability of margin improvements, as underlying insurance margins actually fell to 14% from 14.2% over FY14-16, downside risks are still considered to be reduced.

Trading conditions are actually more positive than Macquarie had suspected. To deliver on its medium-term targets the company needs additional quota share reinsurance, as the targets imply an underlying insurance margin of more than 16%.

Macquarie shares the concern, given the current strength in the company's leading brands, that profitability, market share and customer loyalty may be tested by changes to the system. Long-term targets are ahead of expectations and will require additional capital and earnings optimisation, the broker contends.

Ord Minnett believes the commercial cycle is turning and the company will benefit from entry into the South Australian CTP (green slip) market. This broker is also cautious about the long-term viability of the targeted growth in earnings per share, because of the low-growth nature of general insurance and the company's dominance of that market.

Nevertheless, IAG has the strongest brands and offers the most conservative guidance across the broker's coverage in the general insurance sector. Ord Minnett suspects the market will like the latest cost reduction plans and upgrades earnings estimates by around 4%. The stock price remains a little high for an upgrade and a Hold rating is retained.

It remains unclear as to how much of the targeted savings will find their way to the bottom line and most of the benefits will accrue in FY19 and beyond, Citi observes. The broker expects the transformation to a customer-centric model from a channel and product-centric organisation will mean a significant reduction in local staffing and this carries a reasonable level of execution risk.

FNArena's database shows seven Hold ratings and one Sell (Credit Suisse). The consensus target is $5.78, signalling 1.4% downside to the last share price. The dividend yield on FY17 and FY18 forecasts is 4.6% and 4.7% respectively.

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article 3 months old

The Wrap: Online, Wealth Mgmt, Automotive

Domestic online media; Amazon in Australia; regulatory oversight of financial advisers; risks for automotive dealerships; booming electric vehicle sales.

-Are returns on invested capital sustainable for Australia's online media sector?
-Amazon entering Australia with a retail offering considered negative for incumbents
-Independent investment admin platform providers positioning as threats to incumbents
-Caution prevails as automotive dealer lending practices under scrutiny
-Lithium in strong demand in electric vehicles but excess supply still likely


By Eva Brocklehurst

Online Media

UBS is seeking answers to the question of investing in the online classifieds sector. The issue is about whether domestic online businesses are ex-growth and whether returns on invested capital are sustainable. Is there upside from international expansion?

REA Group ((REA)) may disappoint the market in FY17, UBS asserts. Performance versus expectations relies on second half volume outcomes, which are difficult to predict. The broker believes investors may not fully appreciate the potential for Australian residential revenue to re-accelerate in FY18, even without a rebound in volumes. UBS upgrades to Buy from Neutral and elevates the target to $56 from $52.

The broker notes Carsales.com's ((CAR)) domestic business is perceived as well entrenched, offsetting a lower earnings growth profile. Core domestic revenue growth has slowed to 5% in FY13-16 from 21% in FY10-13. The broker envisages incremental headwinds from retreating dealer profitability pools and competitive threats, and suspects recent initiatives may only be a partial offset. Rating is upgraded to Neutral from Sell with a $10.50 target.

The broker retains a Sell rating for Seek ((SEK)) and a $14.00 target. Drivers of domestic growth include yield, volume and new investments. UBS envisages limited near-term financial contributions from new earnings streams and, instead, expects initiatives will bolster the company's value for its two key stakeholders: hirers & applicants.

A strengthening of the network potentially adds placements but monetisation of a greater market share will be long-dated and the broker suspects consensus expectations for an expansion in margins of 8% in FY18 are unrealistic.

The broker believes, if the three companies could replicate their domestic models overseas, upside would be material, given the penetration of smart devices and rising wealth and urbanisation. On the other hand, market structures are also less favourable elsewhere and competition fiercer.


There is speculation that Amazon will enter Australia. Citi believes the probability has increased albeit this could be 2-3 years away, but the impact on Australian retailers could entail more than a 20% cut to earnings. The broker notes more detailed information has been forthcoming about the company's entry to Singapore in early 2017, with reports signalling Amazon is looking for a retail CEO.

Reports suggest more than 250 trademark applications across a wide range of retail categories have been made by Amazon. This could relate to the export of Australian brands to Asian markets. The broker conceives an entry in 2019 as more probable, given the need to build distribution centres and secure branded supply in Australia.

Citi expects electronics will be the most affected, with earnings declines of 23% predicted for JB Hi-Fi ((JBH)) and 19% for Harvey Norman ((HVN)). This would be closely followed by Myer ((MYR)) at 18% and Super Retail ((SUL)) at 17%.

Wealth Management

Shaw and Partners notes the consequences of increased regulatory oversight has meant Australian financial advisers need to evaluate their business models and, most probably, implement a fee-for-service, and annuity-style business model rather one based on transactions. The main beneficiary from the changing landscape is the customer, with cheaper fees, upgraded transparency and improving advisor education for giving retail advice.

The broker notes a number of independent investment administration platform providers which generate revenue through fees, such as HUB24((HUB)), Praemium ((PPS)), OneVue ((OVH)) and the unlisted Netwealth have experienced notable growth in recent times, positioning as competitive threats to the incumbents such as the banks, AMP ((AMP)) and Macquarie Group ((MQG)).

The broker believes their success has been driven by regulation favouring independent financial advice, competitive pricing and the growth in separately managed accounts (SMAs). Most importantly, their nimble technology has resonated with the advisor community. Nevertheless, the broker believes future growth will be hard to come by, as competitive pressures intensify and pricing models evolve.

The broker believes administration fees will evolve to a flat structure as platform technology becomes commoditised. As well. regulatory burdens will weigh on profit margins and achieving economies of scale will be hugely important for the longevity of the business and industry. The broker initiates coverage of Fiducian ((FID)) with a Buy rating and $4.60 target, Managed Accounts Holdings ((MGP)) with Hold and target of $0.33 and HUB24 with a Sell rating and $4.10 target.

Automotive Dealerships

Further data has reinforced some of the risks facing automotive dealerships. Morgan Stanley also notes BMW Finance will pay $77m to compensate customers for lending failures, which should act as a warning to other finance companies. VFACTS data has shown further underperformance in Western Australia, which is a negative for Automotive Holdings ((AHG)).

Concerns about lending practices have been underscored by the update from Carsales.com at its AGM, where the company indicated its financial services arm sustained borrowing capacity reductions in the fourth quarter of FY16 which continued into FY17. While this is mainly from BMW Finance, which provides finance through Strattons, Morgan Stanley suspects other lenders have been more cautious as well.

The broker believes tightening consumer credit will pose a headwind to new car sales, which are normally financed. The broker is uncertain of the outcome from the pending update on regulation changes from ASIC (Australian Securities and Investments Commission) but believes it will change the way finance is sold at dealerships, which will result in a period of instability as changes are implemented.

Electric Vehicles

Macquarie observes electric car sales are booming and will soon enjoy a large market share. This will have implications for a range of commodities. In 2015, China, North America, Japan and Europe, where the vast majority of such cars are purchased, accounted for 664,000 electric vehicle purchases, more than double the number of 2014. Between January and October this year Macquarie estimates year-on-year growth was another 48%.

The broker believes such sales growth can only be maintained with some difficulty. In 2015 in Europe the increase owed a lot to customers buying ahead of the expiration of generous subsidy schemes in markets such as the Netherlands and Sweden. This year, although many incentives remain, some appear to be expiring at the end of the year. Still, the impact of the burgeoning market is expected to be felt over a long period.

What are the commodities being impacted? So far electric vehicles are pitched at the small end of the market, with limited range or, as with Tesla, a decent range at a higher price point. None are cost-effective compared with standard vehicles as yet. Macquarie estimates around 14% of global lithium demand will be accounted for by electric vehicles this year. Over the long term, average battery capacity should grow.

Chinese lithium spot prices have been falling since May following a substantial rally. Inventory overhang has been blamed. The broker does not believe growth in the electric vehicle market will be fast enough to absorb a wave of supply coming from Australia and elsewhere over the next few years. Nickel, unlike lithium, is used in two of the five prevailing lithium ion battery chemistries.

The demand case for nickel is much less compelling. Assuming that around 50% of electric batteries contain nickel, nickel demand could grow to 38,000t in 2021 from around 10,000t in 2016. Macquarie expects strong growth, but from a low base.

Cobalt is more tied to consumer electronics and China's moves to secure raw material. Given a dependence on Democratic Republic of Congo for supply, there are challenges for its use in electric vehicles and the broker suspects substitution risk is high. Macquarie assumes global cobalt demand for batteries grows at around 5% compound to reach 53,000t by 2020.

Platinum group metals derive most of their demand from autocatalysts, which are found in vehicles with internal combustion engines. The situation is bleak for these metals as both platinum and palladium are expected to experience significant declines in volumes, as autocatalysts from scrapped cars are recycled.

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