FYI | Jun 20 2018
By Peter Switzer, Switzer Super Report
Is the banks’ crucifixion over? Who else thinks they’re a buy?
A strategy that has a good track record is to buy quality companies when the market has beaten up on them because the uncertainty of what’s ahead means the safe bet for professionals is to sell and ask questions later.
A classic case is one of our best companies CSL. Look at this chart, which shows how the GFC panic spooked investors off this great company. And what a buy it was!
And what about Google and the GFC buying opportunity?
Underlining the problem our big four banks have right now was Fairfax Media’s Clancy Yeates, who summed it up neatly: “Australia’s big four banks have slipped into a “bear market” as investors fret over multiple challenges including falling house prices, a regulatory backlash sparked by the royal commission, and higher funding costs.”
However, this noted negativity on these dominant businesses makes me wonder if the worst is over and therefore we’re in buying opportunity territory now. On Friday, CBA was up 2.27%, after hitting a five-year low the day before. Meanwhile, ANZ was up 1.83%, NAB rose 0.81% and Westpac whacked on 2.2%.
Technical experts will say it’s too early to be sure the worst is over, with the bottoming process not clearly completed, but it certainly is getting close to ‘ready set buy’ the banks time!
Is it time to buy?
We know the case for crucifixion of the banks, but let me throw a few positive curve balls at you to build up an alternative view on those who think the banks are finished.
I think this was the smartest observation of the week, and it came from S&P Global Ratings, which said: “The banking royal commission will crimp bank lending growth and pressure interest margins, while credit losses are likely to tick up from their very low levels.”
But I love the fact that the AFR (a quick to judge and be negative outfit) told us that Standard & Poor’s added “the strength of the Australian banks and stronger prospects for the economy should allow the banks to absorb regulatory changes, while higher non-performing loans should be expected, and reflect the economic cycle rather than specific issues in banks’ books.”
And my bank positivity is not a ‘one-man band’ affair.
Last week, Credit Suisse argued the Bank of Queensland is miles below fair value and the current price of $10.26 is a good “buy” price.
In late February, BOQ was about $13 and Credit Suisse has a target of $11.40. Interestingly, the 2018 story might be a little negative but the year ahead is when the bank will deliver, the analysts speculate.
UBS says the banks in 2017 underperformed the overall market by 10%, on a total return basis.
Now we know loan growth is on the slide, after Sydney and Melbourne housing markets went mad for the past four to five years. But have the doubters overreacted with interest rates so low and the economy clearly on a better-than-expected rebound?
Despite some obvious challenges for the banks, one of the country’s greatest bank baggers, CLSA analyst Brian Johnson said he thought “after recent share price falls the banks offered ‘relative value’ compared with banks overseas.”
Hugh Dive, chief investment officer at Atlas Funds Management, also thought the market had become too pessimistic towards banks.
Dive pointed out that weak credit growth meant banks had less need to set aside capital to support lending, which should underpin dividends.
But wait, there’s more.
“In a situation where credit is not really growing very fast, and they sold a lot of businesses, that’s going to return a lot of capital,” Dive said.
Not a crisis of fundamentals
Another fund manager who is long banks is Dion Hershan, the head of Australian equities at Yarra Capital Management. I recently tried to get him to appear on my Money Talks show but he’s not a TV-type. But that doesn’t undermine his reputation as a good judge.
First, like me, he’s a big fan of the Oz economy, as the AFR recently pointed out.
He likes the great economic news we’re currently seeing but is realistic enough to ponder if it can last. However he does conclude: “There is a crisis of confidence, but not a crisis of fundamentals. The economy is in the best condition it has been in for 10 years.”
Hershan says we can’t ignore the great readings on employment and business conditions. And the banks should benefit from a stronger economy in pure ‘more business’ terms.
Meanwhile, commodity prices are driving the likes of Fortescue to announce a new $1.5 billion development of a mine and forecasts for corporate earnings are being pushed up.
Hershan says for 17 out of the past 20 years analysts have started the year optimistic and progressively have downgraded their forecasts for earnings. However, this year it’s the opposite!
And this is the part I liked.
“Yarra has a large and relatively contrarian – position in Australia’s big banks, and so has been watching the royal commission closely,” the AFR reported. “While Hershan has noted a less aggressive tone to the latest round of hearings, he concedes there is a risk it could come up with a set of reforms that has the effect of drying up the supply of credit.”
“I think we need to be really careful of an over-reaction and a policy mistake,” Hershan says.
Interestingly, Yarra Capital Management not only favours banks but certain retailers, though it does not like commercial property and Telstra!
In a post-reporting season update, Hershan, who is the firm’s head of Australian equities, said Yarra (which has $7.5 billion under management) is holding onto its bank stocks, had bought into JB Hi-Fi and Super Retail Group and likes Ansell.
On the banks, Hershan said that the fundamentals in the sector were strong, margins were improving, as lending restrictions allowed lenders to charge higher rates, while bad debts were benign and fears over increased capital requirements had been removed.
I don’t know if Dion Hershan will be right but I hope he is, for the sake of my subscribers, and my fund that is dependent on the banks as critically important dividend-payers.
The banks clearly had a business model problem that too easily disregarded their customers but I’ve always argued that the market has overreacted. It’s good to see someone like Dion Hershan agree.
By the way, he’s not alone.
According to FNArena, the collection of analysts and brokers they survey say that ANZ has 9.8% upside, CBA 6.9%, Westpac 12.6% and NAB a huge 17.7%!
I’m banking on banks to make a comeback, if not now then some time this year, rolling into 2019.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
Content included in this article is not by association the view of FNArena (see our disclaimer).
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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