Australian Banks: The Times Really Are A-Changing

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

In this week’s Weekly Insights:

– Australian Banks: The Times Really Are A-Changing
– Real Correction Yet To Come?
– No Weekly Insights Next Week
– FNArena Sponsors ASX Investor Series
– Share Buybacks – Who’s Doing It?
– Rudi On TV
– Rudi On Tour

Australian Banks: The Times Really Are A-Changing

By Rudi Filapek-Vandyck, Editor FNArena

Prelude

Before reading the story below, remind yourself that, over time, the best performing investments in the share market are those that combine dividends with growth.

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After all the talk about expensive banks… Yet their share prices only seemed to go up, and whether CommBank ((CBA)) shares would be the first to crack the $100 mark, and with stockbrokers and financial planners immensely frustrated by clients and self-funded retirees whose portfolios are stacked up with bank shares, accompanied by strong resistance to sell, even only a small portion…

Australia, last week was the sell-down in bank shares you simply had to have.

What caused it?

Some called it a perfect storm:

– a surging AUD triggered selling by foreign investors

– global government bond yields corrected higher (investors selling)

– a weaker than expected local banks reporting season (across the board)

– banks clearly indicating a need for capital and restraints on dividend growth

– one massive capital raising by National Australia Bank ($5.5bn)

– investors globally starting to unwind “crowded trades”

At the very least, Australian investors have now witnessed, first hand, that Australian banks can suffer weakness when headwinds appear and the underlying tide turns. It’s not all just talk and market noise. Viewed from this angle, 2015 is turning into an exceptionally intriguing experience with earlier in the year yet another SMSF staple, Woolworths ((WOW)), falling off its pedestal.

It remains yet to be seen whether weakness in bank shares is going to change investors’ perception and attitude towards the sector. Yet, with some financial planners informing me during the week many of their clients have 80% of their investments in banks, losses suffered in weeks past greatly exceed the thus far relatively mild pull back for the ASX200.

– ANZ Bank ((ANZ) shares have now fallen from $37 to below $32 (minus 13.5%)
– Commbank shares dropped from $96 to $82 (minus 14.5%)
– Westpac ((WBC)) shares have fallen from $40 to circa $33.50 (minus 16.25%)
– National Australia Bank ((NAB)) shares are in trading halt pending capital raising [reopened $34.50, down from $39.50, or minus 12.7% – Ed]

Note: year-to-date performance for CBA shares is now negative.

Which leads to the obvious question: time to go hunting for bargains?

What A Great Run It Has Been

Before I try to answer the question, I’d like to grab this opportunity to insert a little flashback and highlight the value of research and analysis published here at FNArena.

On numerous occasions in the past have we come out to make strong conviction calls: Sell the banks in late 2007/throughout 2008; Sell Rio Tinto when the share price was above $115; Sell energy stocks in mid-2008; Beware of the Biggest Commodities Sell-Off in Modern History in late August 2008… most of these calls were negative. They warned of losses if investors stayed the course.

However, in 2009, well after the initial recovery rally, I made a Big Call on bank stocks, predicting investors would enjoy 100% total return in the decade ahead, just like they had throughout the nineties and in the years leading up to the GFC. At that time my prediction was republished elsewhere and it caused quite a stir. Even here at FNArena, subscribers queried whether I had lost my marbles.

Yet, here we are, six years later, and the performance of bank shares has significantly exceeded my bold prediction. Consider CBA shares were trading around $50 in October 2009. Annual dividend yield has been 4.5%-5%+ for six years. Even at today’s share price, post correction, total return for the period is still close to 100%, certainly if we include franking benefits.

This, of course, is exactly the reason as to why bank shares have become staple stocks in every SMSF portfolio and why the owners of these portfolios have been so reluctant to sell any shares. But what did Warren Buffett say about the most common mistake made by investors? They look over their shoulder into the past instead of looking forward into the future.

Let’s look forward into the future then…

The Tide Really Has Turned For The Banks

Too many market experts and commentators, on my observation, live in the here and now. Instead of focusing on the results that have been reported last week, I equally pay attention, if not more, to what these results mean for the outlook for banks in terms of growth, dividends and balance sheets/capital requirements. This is the full package, and it does not instill a lot of enthusiasm.

Bank analysts, and others, have been talking about increasing challenges and headwinds for the sector for a while, but until last week these warnings and predictions never genuinely showed up in real life. This is why last week’s bank reports have proved so important. They marked a significant reversal in underlying trend. Banks in Australia are no longer a bunch of happy-chappy oligopoly-bastards that squeeze customers for every penny they can get, but reward them as shareholders with ever rising share prices and dividends. The challenges have started to materialise. Limits are becoming tangible and real. Headwinds are building. Risks are rising.

To put it in simple terms: until a few weeks ago, bank stocks had been enjoying an underlying current of continuously up-trending profit forecasts, which meant that share prices, despite all the criticism and doubt surrounding them, also kept trending upwards. That underlying trend has now abruptly ended. One must now fear the future holds an underlying current of downward-trending forecasts, with risks rising significantly in case the Australian economy deteriorates or bond rates rise quicker than anticipated.

Sure, we are still in a low yield environment and this will continue to provide support to bank share prices, but there’s now a real and genuine offset in the sector being seen as growth-challenged (ex-growth), in need of extra-capital and with real restraints on the horizon to further grow dividends.

One look at Stock Analysis on the FNArena website suffices to see that none of what I have written so far is exaggerated. This is how analysts are now looking upon the sector. Solid yield, but growth-challenged.

Banks Need Capital

Banks may have lost their perceived invincibility, and they are by no means the next iron ore experience. Yield without growth is still yield and at some point there will be enough buyers around to push share prices higher than where they are today. The lack of growth does warrant a lower valuation because there is less of a safety margin against future risks.

However, National Australia Bank’s surprise in the form of a $5.5bn capital raising should not be taken as the blueprint for what follows next for the sector in general. NAB needed the extra capital because it really, really, really wanted to get rid of its troublesome UK operations but UK regulators were never going to agree to any separation without sufficient capital for the local operations. This simply goes to show that troubled operations, no matter how small in the bigger scheme of things, can have a large negative impact for many years. See also “GFC” and Woolworths and “Greece”.

Increased regulatory requirements, however, might force all the banks to strengthen their capital and this is why Dividend Reinvestment Programs (DRPs) are becoming popular again. DRPs are there to entice shareholders to opt for scrip instead of cash. For the banks they are but a capital raising under a different label. All banks believe regulators will grant them a few years time to reach new capital requirements. Hence, a few years of DRPs should hopefully fix that problem.

For shareholders, this means a rising barrier to dividend growth because the number of outstanding shares grows. (Mind you, we yet have to hear from APRA about the new capital requirements, so all this may well stay an unquantified risk for a while).

Valuations Have Come Down To Earth

Bank shares have lost their market premium, but does this now imply they are cheap and represent good value?

Historically, the sector trades inside a Price-Earnings (PE) range of 9-12 in truly bad times and 13-15 in good times, for an overall long-term average of 12.5x. The reset has now pushed CBA, Westpac and NAB back inside the upper range while ANZ Bank shares look cheap at 12.1x FY15 and 11.6x FY16 consensus estimates.

A similar picture emerges when we look at the respective dividend yields, which are back above 5% for CBA, above 5.5% for Westpac and NAB, with ANZ Bank closer to 6%. Again, this seems fairly in-line with historical values, with exception of ANZ.

The same observation stands when we look at consensus price targets. All major banks’ share prices are now trading a few percent below consensus price targets, an event not often witnessed since they started to rally in 2012. On Monday, ANZ Bank shares are more than 10% below consensus target, confirming the observations made earlier.

No doubt, bargain hunters will try to close the gap between share prices and price targets, but I very much doubt whether the sector can regain its premium in the short to medium term. Investors should not expect bank shares to trade above targets for a prolonged period, if they do get there at all. In case of rising bond yields, there is less protection because there is no growth.

Investors should definitely not expect to see share prices back where they were only a few weeks ago, not anytime soon.

Beware The Woolies Experience

A falling share price does not automatically mean there’s a value opportunity opening up. Investors should also pay attention to the reason as to why the share price has weakened. This year’s Woolworths experience, yet another SMSF staple, is one perfect example.

One year ago, Woolworths shares (can you believe it) were trading at $38. They were trading around $36 when investors panicked a first time and became worried about loss of momentum, pressure on margins and the wider “UK experience”. That was in November last year. The share price quickly retreated below $30, only to rally back above $34. Silly market.

Only then bad news genuinely started to come out and the share price quickly reversed back to $29, after which believers and non-believers started a push-pull fight that ultimately has led to the share price failing to recapture $30 and instead trend towards $27.

Is Woolies good value at these levels? No doubt, on a long term horizon, and assuming management does fix what needs to be fixed at the once All-Weather solid food and liquor operations, today’s share price will look like a good entry point, but this doesn’t mean the share price won’t go below $27 on further general share market weakness and ongoing investor scepsis. I wouldn’t be surprised if Australian banks do a Woolworths in the weeks ahead, though I must add, the general tepid investor response post-sector sell-off speaks a thousand words.

Disclosure

Most of you would be aware by now that FNArena is running an All-Weather Model Portfolio through Self Managed Accounts (SMAs) on the Praemium platform, based upon my own post-2008 research.

I can happily report the Portfolio has zero point zero exposure to the Big Four in Australia. None to Woolworths either.

Yield Alternatives

I am not going to preach about risks in relation to heavily overweight positions to one particular sector in investment portfolios. Recent events speak for themselves.

Investors looking for alternatives to the banks and Woolworths, might consider Asaleo Care ((AHY)), APA Group ((APA)), Flexigroup ((FXL)), Goodman Group ((GMG)), Macquarie Group ((MQG)) and Transurban ((TCL)). All these stocks are on my personal watch list and/or part of FNArena’s All-Weather Model Portfolio.

Real Correction Yet To Come?

Some count waves. Others talk about the technical damage done by the turbulent sell-offs since April. Remarkable is that many of the seasoned and/or technical oriented experts are in agreement: equities are going through a corrective phase and the end is nowhere near in sight.

This is what reputed market trader Dennis Gartman had to say about global equities on Friday:

“We shall call this a bounce… a correction… a “taking back” of the massively over-sold condition that had existed one day previous, but do we believe that the weakness in the equities markets has run its course? No, we do not. We fear that weaker prices lay still ahead and that the upward sloping, but rather broadly drawn, trend line in the S&P[500] noted here yesterday that offers support at the 1900-1940 level can be, should be and likely will be put to test before this correction that began earlier last week has run its course.”

Quite a number of chartists across the globe are sticking to the prediction that US equities will have that 15-20% correction everybody has been talking about since 2012. From a fundamental point of view there are plenty of factors that could trigger such an event, including:

– a sudden shift in Fed rate hike expectations
– another flash crash as over-popular trades are being wound back and liquidity becomes tight
– government bonds do what everybody is afraid of: they sell-off (yields spiking higher), whatever the reason

Technical analysts at UBS recently reiterated their forecast that a much greater correction still lies on the horizon for US equities. Recent price action fits in neatly with their blueprint of a choppy market that will find further upside much tougher en route to a temporary peak into late May/June when rising bond yields and a stronger USD are expected to -temporarily, mind you- break this bull’s strength and open the gates to a much greater correction downwards; 15-20% lower.

The analysts call this scenario their “High Conviction Call”.

The good news behind all of this is that the UBS tech team also believes the upcoming correction will be just that, a correction; a temporary set back in an ongoing bull market. Shorter term, however, there should be no guessing where the selling pressure is going to come from: “we have the setup to see a negative surprise in global bond markets into early summer, which from a macro perspective suggests increasing headwind for global risk/equities”.

Probably best to stay nimble and not get carried away with any upward movements. Markets do have that tendency to suck in more money and renewed confidence/enthusiasm, before they take it all away.

No Weekly Insights Next Week

Weekly Insights will skip one week and return on Monday 18th May 2015, for paying subscribers, and two days later on Wednesday for non-paying members.

I shall retreat in Canberra next week for a presentation to the local cell of Australian Technical Analysts’ Association (ATAA) and intend to use the remainder of the week to reflect, research and write the next eBooklet for FNArena subscribers. Watch this space.

FNArena Sponsors ASX Investor Series
 

ASX Investor Series, Sydney May 19, 12:30pm -2pm

Don’t miss the next opportunity to hear from CEOs over lunch with an informal meet and greet session at the conclusion of presentations. Speaking at this event are Aveo Group, Auswide Bank, Dyesol,  Energy Developments, and 8I Holdings Group.  

These events are free to attend however registration is required as seating is limited. Register here

Share Buybacks – Who’s Doing It?

Below is an incomplete overview of companies buying in their own shares this year. We very much appreciate all contributions and suggestions at info@fnarena.com

– Amcor ((AMC))
– Boral ((BLD))
– CSL ((CSL))
– DWS Ltd ((DWS))
– Fairfax Media ((FXJ))
– Fiducian ((FID))
– Finbar Group ((FRI))
– GDI Property Group ((GDI))
– GWA Group ((GWA))
– Industria REIT ((IDR))
– Logicamms ((LCM))
– Matrix Composites & Engineering ((MCE))
– Nine Entertainment ((NEC))
– Orica ((ORI))
– Pro Medicus ((PME))
– ResMed ((RMD))
– Rio Tinto ((RIO))
– Seven Group ((SVW))

Wants to buy in own stock (but still awaiting shareholders approval): Intrepid Mines ((IAU))

Rudi On TV

– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Wednesday, Sky Business, 8-9pm, Your Money, Your Call Equities (host)
– on Thursday, Sky Business, noon-12.45pm, Lunch Money
– on Thursday, Sky Business, between 7-8pm, Switzer TV

Rudi On Tour

I have accepted invitations to present:

– May 19, ATAA Canberra
– May 29, CEOs lunch French Chamber of Commerce
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland – for more information about this event:

http://www.investors.asn.au/events/events-schedule/aia-national-investors-conference/

Note: FNArena subscribers can attend at similar discount as AIA members

(This story was written on Monday, 11 May 2015. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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THE AUD AND THE AUSTRALIAN SHARE MARKET

This eBooklet published in July 2013 forms part of FNArena’s bonus package for a paid subscription (excluding one month subscriptions).

My previous eBooklet (see below) is also still included.

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MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS

Odd as it may seem, but today’s share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.

The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.

Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena’s free bonus package for a paid subscription (excluding one month subscription).

If you haven’t received your copy as yet, send an email to info@fnarena.com

For paying subscribers only: we have an excel sheet overview with share price as at the end of April available. Just send an email to the address above if you are interested.

Click to view our Glossary of Financial Terms