Dougal Maple-Brown
Viewpoint
- After bottoming in mid 2023, the Banks have outperformed the market by around 20%[1].
- We have favoured the Banks over the past year, more off the back of reasonable valuations, rather than particularly exciting earnings growth.
- The recent re-rating of the Banks has seen us trim our positions, however the Bank sector still looks reasonably attractive relative to Industrials.
Any way you cut it; the Banks have had a pretty good run. After bottoming in mid 2023, the Banks have outperformed the market by around 20%[1] and if anything that outperformance has accelerated into the first few months of this year. The reasons for that outperformance aren’t overly clear: only CBA reported full financial results in the recent February reporting season and those results were pretty underwhelming. At a pre provision profit level CBA actually missed consensus expectations, with the bottom line result saved in our view by a low credit charge.
There have been some reports of foreign buying of the Banks, particularly by Asian investors searching for ‘anything but China’. You can see why big, liquid Aussie Banks fit the bill here, particularly given Australian Resource stocks are generally considered a leveraged play on China.
Over the past year our portfolios have held overweight positions in ANZ, NAB and Westpac. Our thesis over this period was premised on sensible earnings forecasts and reasonable valuations, particularly when compared to many Industrial stocks. At the time we (and consensus) were forecasting lacklustre credit growth, ongoing Net Interest Margin (NIM) compression, growing costs and a modest credit cycle. Not surprisingly, those assumptions drove limited earnings growth and hence forecast total return was largely limited to the grossed-up dividend yield.
While that earnings profile didn’t look very exciting, in our view valuations were very reasonable. A year ago ANZ and Westpac were trading around book value or 10x forward earnings. On a bad day they even traded below book! NAB was slightly more expensive, but still well below the premium rating enjoyed by CBA.
Finally, market sentiment towards the Banks was terrible. This peaked after the May 2023 Bank ‘Reporting Season’ when NIMs were being crushed in the midst of a mortgage pricing war. Brokers were universally bearish and even Bank management teams we saw at the time were quite concerned.
Yet less than a year later, Banks have handsomely outperformed the broader market[1]. As always, our job is to judge the stocks on what we see before us. Frankly, we believe earnings still look pretty sensible and yes still pretty unexciting. What has changed is the rating. The chart below from Goldman Sachs suggests the Banks are now trading on a P/E of around 16x – a 35 year high. Furthermore, Goldmans also make the point that historically P/Es have expanded when earnings are depressed. Earnings today for the Banks seem pretty close to ‘normal’ – as far as such a concept exists for Banks!
Source: Goldman Sachs, date to March 2024.
So where does that leave us on Banks?
We have been trimming our Bank positions as valuations have become less attractive. The speed of our selling is of course also influenced by other buying opportunities. It is here the story gets more complicated, given Industrials (ex Financials) as a whole still trade at a full ~25x forward earnings[2]. Thus, relative to Industrials, Banks are closer to fair value rather than outright expensive.
Source: Goldman Sachs, data to March 2024.
Parting thought
The Big Four remain a strong pillar of the Australian economy and make up over 20% of our equity market. While arguably less strategic levers exist for bank boards than did five years ago, we continue to focus on the challenges facing the banking sector, earnings outlook and valuations as share price drivers. As a value-based active manager we will adjust our exposure to the Banks as valuations dictate, just as we have over the last year.
By Dougal Maple-Brown, Head of Australian Value Equities
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