Why would you buy banks? Traders are saying the stocks are due for a pull back while longer term investors have gotten a cut in dividends and warnings of bad debts and more economic pain ahead. On the other hand, the major banks are trading at price-earnings ratios of less than 12 and yields on forecast earnings are around 6%.
IG Markets research analyst Ben Potter says the banks are still good investments and cheap on historical terms. But he says traders have started to rate the stocks as a sell.
“They have run up very hard and were ahead of where they should have been so a lot of traders are saying they are downgrading them to a sell. The general feeling seems to be they will be a buy soon, but probably not at these levels.”
Potter rates Westpac as the pick of the majors, saying it is very well managed and offers superior growth.
Shaw Stockbroking financial stocks analyst Tim Buckley agrees the banks have had a strong run and says they are reasonably fully priced on current earnings. “It does come down to your time line though.”
Buckley has accumulate ratings on the Commonwealth Bank and Westpac, but says he is looking to 2011 earnings to justify that recommendation and in the meantime “they are paying you to wait with a fully franked yield of 6%, well above the cash rate.”
He prefers the Commonwealth and Westpac because they have demonstrated a strong business model with low risk and he expects robust growth from them over the longer term.
The market had factored in dividend cuts and lower revenues before the recent half year profit reports by ANZ, Westpac and NAB but the banks surprised analysts with the extent of their bad debts. Since the market hates surprises and analysts thought they had accounted for corporate collapses and earnings’ guidance, the results got them speculating on what other bad news lies ahead, particularly on property lending. However, it seems that the headline-grabbing collapses last year were easier to factor into results than the next wave of bad debts which came from small and medium-sized businesses. Banks have also become more reluctant to give guidance on bad debts according to one analyst, who says “I can understand it as it is very difficult even if you are an insider at the bank to know where your bad debts will end up.”
In a survey of the half year results, Credit Suisse analysts found impaired assets of the three rose, in aggregate, to 93% of loans compared with 34% in the first half of 2008. They said the rise in impaired loans and bad debts was unexpectedly sharp and early and also noted that revenue growth before financial markets income, a measure of operations from traditional banking, only rose by 3% for the big three.
Although the firm’s equity market strategists have a “market weight” position on the banks, believing they are inexpensive, the financials analysts say they cannot easily see value in bank stocks until the risks inherent in the bad debt charges can be estimated more reliably.
Among the majors, they have rated the banks in order of preference as: CBA, Westpac and National Australia Bank. The firm has a policy of not making a recommendation on ANZ because of business ties between the two. They say majors are expensive at 13 times estimated earnings for 2010 but inexpensive at nine times estimated earnings for 2011, when they see earnings recovering.
The analysts do have outperform ratings on the Bendigo and Adelaide Bank, Bank of Queensland and Suncorp-Metway based on their lower multiples. Although the smaller regional banks face a tougher time in debt markets, they are well positioned to gather deposits from their network of expanding retail branches.
The strong run by the major banks has taken the shine off other financial stocks but Shaw Stockbroking’s Tim Buckley rates QBE as good value below $20.
“They have raised a fair chunk of capital and restored their balance sheet. They have also demonstrated they have a very good handle on their business,” he says.
Although it failed in its takeover bid for IAG last year and lacks a catalyst for growth, Buckley believes it is only a matter of time before QBE makes an acquisition and says investors could buy on weakness and wait for the stock to be re-rated.
He says the insurer has a good track record on acquisitions, has a much stronger balance sheet than three to six months ago and since it has to mark to market its liabilities based on government bond rates, it is freeing up capital as those rates rise and therefore has more firepower for acquisitions.
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