Rudi's View | Mar 29 2023
This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA
In this week's Weekly Insights:
-More Data, More Brokers
-US Recession More likely
-(Not) About The Banks
By Rudi Filapek-Vandyck, Editor
More Data, More Brokers
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US Recession More likely
Nothing is set in stone when the subject is financial markets, but a financial crisis for regional banks in the US will, all else being equal, put further strain on the availability of credit and thus hamper economic growth.
All talk about a 'no landing' scenario should now definitely been relegated to the sin bin. There will most likely be a 'landing' for the US economy in the twelve months ahead.
As to exactly how 'soft' or 'hard' that landing might be is still dependent on multiple factors and yet to be established outcomes.
Common logic suggests markets will opt for a reduced risk approach, at least until more clarity emerges about the consequences for US businesses and economic growth.
Then again, common logic is not always that common, and the prospect of a boring sideways channel would not excite many who make a living out of daily volatility.
(Not) About The Banks
Today's story is about Australian banks, except it isn't. Not really.
Hopefully this is not too confusing already, but Dear Reader, you will have to read until the end to understand what this story really is about.
As said, I'd like to start off with Australian banks.
For more than a decade now, CommBank ((CBA)) has been priced at a sizeable premium versus other banks in Australia.
The embedded gap in valuation attracts both criticism and amazement; to many Commbank shares sit right at the bottom of industry rankings; other banks on cheaper valuations look so much more attractive.
This is the case today as it has been at any point post the GFC.
The obvious contradiction here is that CommBank shares have not underperformed throughout those years. To the contrary, CommBank shares today are the one sector exception in that the shares have managed to rise above their peak from back then.
The only one in the sector locally.
Fifteen years after the GFC, all other bank shares in Australia are still trading (well) below the levels recorded in 2007.
Popular explanations for CBA's valuation premium, there are many, but the most quoted and most credible on my observation, is that CommBank is simply Australia's superior bank – better than all the rest.
Testing The Thesis
To genuinely test the thesis, we must have an impartial, non-subjective, unbiased method for measuring the corporate quality for CommBank and the others. Is there a difference at all, and can we measure it?
Investors own the banks for regular and reliable income. Also, whereas profits and related financial metrics are heavily subjected to accountancy decisions made, dividends are paid out of cash, a much more straightforward and equalising measurement.
If CBA is truly the superior among peers, this must show up in the banks' common history of paying out dividends to shareholders.
The table below (with thanks to FactSet) shows the dividend payments per financial year for each of the Major Four in Australia. Whenever a dividend was cut from the year prior, the payment is shown in pink. If a dividend was left unchanged, the highlight is in yellow.
Overall, Australian banks' positive view among local investors stands out from the table: in most years dividends increase, for all four banks involved.
Let's zoom in on what happens when industry conditions get tougher, like, for instance, back in 2007 when ANZ Bank ((ANZ)) stopped lifting its dividend while others still were, followed by reduced dividends from all in 2009 as a result of the Global Financial Crisis.
Two observations stand out already:
-In the subsequent post-GFC recovery, CBA was the only one who raised the following dividend payment above the 2008 payout
-All others took multiple years to achieve the same outcome:
-Both ANZ Bank and Westpac required an extra year
-It took NAB five more years to raise its dividend in 2014 above the payout prior to the GFC-fallout in 2008
Let's move on to the next time when Australian banks were seriously challenged:
-In 2016 both NAB and Westpac started freezing their dividends
-ANZ Bank, however, cut its dividend and then kept it unchanged for the next three years
-CommBank kept lifting the annual payout, admittedly in small increments, but the difference is there
By 2018 CBA too is no longer increasing its annual dividend. The following year both NAB and Westpac are cutting. By 2020 the global pandemic is among us and all four are yet again reducing their dividend.
-Heavy reductions from ANZ, NAB and Westpac sharply contrast with a milder reduction at CBA
-This time around the impact on the subsequent recovery is long-lasting for all four banks. Dividends have been rising since the 2020 cut, but as yet no dividend has matched the payout from 2019.
-Looking at current consensus forecasts does open up the same old discrepancy with CBA's dividend to come close to matching the 2019 payout in the current financial year, with FY24 destined for a new all-time high in nominal terms.
-The same projections are in place for ANZ Bank, but this bank started cutting in 2016. If we measure from its dividend peak in 2015, it looks like ANZ Bank is likely to require another 1-2 years before that old dividend record can be exceeded.
-Projections for NAB and Westpac suggest their shareholders may have to wait until FY26, at least, before payouts have recovered to previous levels.
I assume we can all agree the history of dividend payments by the Big Four Banks in Australia shows that:
-Dividends from ANZ, NAB and Westpac are much more vulnerable during times of stress and duress
-The threat of a dividend reduction from CBA is significantly smaller
-Combined with a quicker recovery, this makes the long-term trajectory in dividends from CBA more robust and steeper in its uptrend
I think we can all agree, CommBank is the superior operator inside the Australian banking sector, and it shows up through the one measure Australian investors value most; income from annual dividends.
How To Value Superiority?
In the second part of our investigation, we look at how CBA shares have performed relative to others in the sector.
The table below shows the annual relative performance through three colours:
-Pink: CBA shares underperformed at least 2 of the other three banks
-Yellow: CBA shares were the second best performing that year
-Green: CBA shares outperformed all others
What the overview clearly shows is that, overall, investors' appreciation for CommBank's superior report card looks very different pre-GFC as it does post 2008.
In the past 14 years, CBA has either outperformed all others or proven second-best in 11 of those years. Thus far in 2023, CBA and ANZ Bank are outperforming NAB and Westpac, hence that underlying trend remains well and truly in place.
Looking at the pre-GFC years, however, shows no such pattern with CBA shares only outperforming in three of the eight years between 2001-2008.
A possible explanation that springs to mind is that, pre GFC, CBA being the "better" bank was mostly a topic of public debate and interpretation. Investors were clearly more focused on relative valuations back then. The bank that commanded the higher valuation in one year would be punished for it later on.
Equally interesting to note is that in the years leading up to the GFC, dividends from ANZ Bank and Westpac were increasing at a faster rate than those from CBA and, back then, with the sector laggard plagued by multiple scandals and problems, NAB.
With the advantage of hindsight, we can today also conclude those years were the final window in the golden era for banks globally that lasted for most of the prior two decades.
With that golden era well and truly behind us, and banks encountering GFC, pandemic and credit crises, the trend-trajectory in CBA dividends stands head and shoulders above the rest in Australia. Consider, for example, Westpac is forecast to pay out the same 138c in the current financial year as it did back in 2010! (NAB is still paying out less).
Is this a case of true Quality only proving its mettle when tougher times arrive? Or maybe it simply takes time before paying out less to shareholders and reinvesting more in the business accumulates into a true and tangible difference? Whatever the explanation, one thing that certainly doesn't lie is the difference in share price performances between CBA and its three major peers post GFC.
As per the overview below, in the first decade of the nougthies, CBA was simply one of the pack. One year better, in other years a laggard. But all investment returns calculated post 2010 leave no room for interpretation. Both ANZ and Westpac have effectively seen no capital gain since 2010. NAB achieved small progress, but that's on the back of the horror decade that preceded.
A Sign O' The Times?
So… the most expensive stock in the sector provides the highest return and the cheaper alternatives are cheaper for a reason. No doubt, most investors are well and truly shocked-to-the-core by now.
Unless, of course, the past is behind us and tomorrow awaits a fundamentally different world?
One popular narrative doing the rounds is that excess liquidity and extremely low bond yields have throughout the decade past fueled an over-emphasis on Quality and Growth, with those assets being priced at unsustainable, high valuations that leave no further room for a positive return in the years ahead.
But is it really that simple? Has the market not already corrected from the general reset in interest rates and bond yields? Also: why exactly would CBA more than other banks benefit from central banks providing liquidity?
A more plausible explanation might be that, overall, the global context has changed and part of that broad change includes investors now valuing extras such as reliability, sustainability, predictability and consistency on top of yield and profits. If CBA shares trade at a sizeable premium versus other banks, and they have been doing this for more than a decade, is this still an aberration or a new reality?
Not one single analyst who's looked at valuing CommBank shares in isolation in years gone by has ever concluded the shares did not look 'expensive'. Yet, this has not prevented those shares from posting a new all-time record high as recent as earlier this year.
These observations raise a few obvious questions:
-Maybe CBA's valuation should be best considered in relative terms, i.e. including a premium versus the sector generally
-Shrinkage and/or widening of that relative premium might be the better indicator of whether CBA shares truly are 'expensive' or 'cheap'
-If history repeats itself, times will become tougher for banks. Can CBA once again shine as the safer and stronger of the local banks?
While we don't as yet know the answer to that last question, it is most likely investors will grant CommBank the benefit of its historical track record, until proven otherwise.
As investors, we always need to keep our eyes and mind open for any changes that might disrupt the status quo, but it is equally important to consider whether CommBank is indicative of a much wider phenomenon that, in a similar vein, makes other Quality stalwarts look a lot more 'expensive' than they in reality are.
P.S. It is my view CBA's superiority has been achieved on the back of more targeted, sizeable investments made throughout the years, whereas others have been happy to put more in shareholders' pockets.
CBA's payout ratio has been consistently below its peers'. This may not seem like a major item on a short-term view, but accumulated over many years, it does make a substantial difference.
Quod Erat Demonstrandum.
(This story was written on Monday, 27th March, 2023. It was published on the day in the form of an email to paying subscribers, and again on Wednesday as a story on the website).
(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.
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