Bank Outperformance Ends, But Fear Not

Australia | Apr 13 2021

Banks no longer offer deep value, but despite headwinds brokers expect the sector to benefit from a broader economic recovery

-Earnings and dividends upgrades through 2021
-Regionals favoured over majors
-Sector to trade higher on credit growth & capital management
-Dividend revisions significantly outpacing earnings revisions

By Mark Story

Banks outperformed the broader market by around 3.5% in March, bringing the year to date outperformance to 12%. Over the past six months, ANZ Bank ((ANZ)), up 58%, has been the clear outperformer, followed by National Australia Bank ((NAB)) and Westpac ((WBC)) both up around 43%.

Reflecting lower leverage to the recovery and the benefit of starting from a stronger position, without the need to raise equity during covid, Commonwealth Bank ((CBA)) has by comparison lagged (up 30%).

While still based on depressed earnings estimates, price/earnings ratios (PE) have risen from 11x to 16x across the big four banks. Relative to the market, Wilsons notes the sector trades at 0.88x, just above the long-term average of 0.85x. 

Based on the prospect of further earnings and dividends upgrades through 2021 and capital management in the December quarter, Wilsons believes this gap is likely to close.

Hard to be overly bullish

But despite this marking the seventh month in a row in which banks have over-performed, stretched valuations and longer-term headwinds have made it difficult for analysts to be overly bullish on the sector.

While tighter lending standards could add to the sector’s future headwinds, commentary from the banking regulator APRA suggests there needs to be clear evidence of a deterioration in lending standards before macro-prudential restrictions would be required. But assuming house price growth continues at the current pace, JPMorgan expects macro restrictions to be reintroduced later this year.

While Wilsons believes Australian banks no longer provided the deep value on offer in September quarter 2020, the broker continues to see upside across the industry as the economy recovers, lending growth improves and strategic initiatives take hold.

Given the prospect of further upward moves in long bond yields through 2021 and acceleration in the domestic recovery cycle, Wilsons also expects market conditions to continue to remain reasonably favourable for banks.

While valuations have risen dramatically from 0.9x book value in the September quarter 2020, the broker notes share prices are still 15% below levels implied by looking at the long-term measures of price to book ratios. On the same basis, share prices are -30% below 2015 levels before the multi-year bank de-rating process ended in mid-2020.

However, Macquarie believes that a positive balance sheet and margin trends, coupled with likely upside risk to earnings from lower impairment charges, provide a favourable earnings backdrop. But given these considerations are well understood, and reflected in share prices, Macquarie retains a Neutral sector view. The broker favours the regional banks over the majors, with its preferred exposures being Bendigo & Adelaide Bank ((BEN)) in regionals and ANZ among the majors.

Key areas of focus

Despite the strong rebound in banks, Credit Suisse believes the sector can trade higher in the near term due to regulatory environment - versus 12 months ago - credit growth (the fuse for revenue growth) and capital management.

While Wilsons expects the upcoming bank results season (May) to be well received by the market, the broker expects it to be shaped by four areas of focus: Bad debt provision reversals, higher dividends, pathways to capital management - which could potentially total around $20bn in size across the sector over FY22 - and new strategic initiatives.

While consensus provisions for bank sector bad debts have halved since December 2020 from around $8bn to $4bn - off the back of stronger domestic economic performance - Wilsons thinks provision levels still look excessive given the economic performance of Australia.

On the dividend front, the good news for investors, adds Wilsons, is that dividend revisions are significantly outpacing earnings revisions. In terms of first half 2021 dividend per share (DPS) estimates, Wilsons notes the market is currently looking for 80% growth on second half 2020.

When it comes to surplus cash, Wilsons suspects the banks will show investors a pathway to capital returns in May, but will not act until the November FY21 results.

Wilsons Australian Equity Focus List remains overweight on the banks with 300bp active position across ANZ, NAB, and Westpac. The broker has zero exposure to CBA primarily on relative value grounds and expectations around the value/growth rotation theme, which likely has at least another six months to run.

Credit growth & risked based lending

Housing credit growth improved in February to around 5%, but Macquarie notes the upside to balance sheet growth fell short of implied December 2020 commitments data.

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