There is no shortage of analysts and commentators suggesting Australia’s big-four banks are overvalued and at risk of a share-price correction. Slow credit growth and the risk of a property-market bubble potentially leading to more bad debts are ammunition for critics.
My main concern is small investors buying bank stocks as a surrogate for cash or fixed interest. The Commonwealth Bank’s gross-up trailing dividend of 6.7 per cent looks a lot better than 3-4 per cent in a bank term deposit for income investors. But it comes with significantly higher risk.
I would neither buy nor sell the big-four banks at current valuations. Long-term investors who have enjoyed stellar share-price gains this year in the Commonwealth Bank, Westpac, ANZ or National Australian Bank should continue to hold them, possibly taking some risk off the table by opting out of dividend reinvestment plans that automatically buy bank shares at elevated prices. That income should be deployed to other market sectors, and away from fully valued big-bank shares.
Those who want to buy bank stocks should look closer at the second-tier plays: Bank of Queensland (BOQ), Suncorp, and Bendigo and Adelaide Bank, a new addition to this column’s watch-list. Although they have rallied this year, the smaller banks still offer reasonable long-term value.
BOQ, a column favourite, has been covered here in recent weeks. My interest in BOQ stems from its leverage to the recovering Queensland residential property market, and internal improvement led by a strong management team. Its one-year total shareholder return (including dividends) is 74 per cent. Suncorp has returned 45 per cent over 12 months.
Bendigo and Adelaide Bank has kept pace with a 41 per cent total return over 12 months. Bell Potter Securities this week increased its 12-month share-price target on Bendigo from $11 to $12, a valuation it described as “undemanding” given an expected 10 per cent Return on Equity. Bendigo hit a 52-week high of $11.38 in October, but has eased to $10.76 in recent weeks.
If Bell is correct, Bendigo could offer 11 per cent capital growth over one year and yield almost 6 per cent, based on consensus analyst forecasts, giving a 17 per cent total shareholder return (more after franking credits). Bell is more bullish than most on Bendigo: the average price target of brokers who cover it is closer to $10, at June 2014. Some have targets in the mid-$9 mark. But Bell’s optimism on Bendigo is well placed, and it has covered regional banks as well as anyone this year.
In a report this week, Bell said: “Since the GFC, BEN has successfully demonstrated its ability to: (1) adapt to “new normal” banking conditions (soft credit growth, greater competition from the majors and regulatory changes requiring higher-risk capital and liquidity from smaller players); (2) grow the franchise profitably without compromising margins and credit quality; and (3) improve productivity and efficiency while maintaining investment in front-line capabilities.”
Bendigo has an excellent brand and high customer ratification ratings, but suffers from a smaller customer base and higher funding costs. Still, Bendigo has a relatively low-risk business model, well-diversified revenue base, and a good long-term record.
However, after strong price gains this year, Bendigo is due for a pullback. It is already off 5 per cent from its 52-week high and further share-price weakness would not surprise as expectations build for the US Federal Reserve to taper its quantitative easing program, and global sharemarket volatility rises. If Bendigo falls through $10.70, the next major support level on its price chart is $10 – almost exactly in line with the average consensus 12-month price target among broking firms.
Whatever happens, Bendigo deserves a spot on portfolio watchlists. Like other bank stocks, it provides decent fully franked dividend yield (7.6 per cent after franking credits) for long-term income investors, and has a reasonable valuation.
With Bank of Queensland, it looks a reasonable way to gain exposure to the banking sector and the quickening recovery in residential property markets.
Click on the links below to read other articles from this week’s newsletter
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at November 13, 2013.