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It’s been six months since the Big Four Banks hit 52 week highs and analysts and market commentators dredged up the “overvalued” arguments heard many times over the past five years.  

Five years ago investors were treated to growing concerns over an Australian housing bubble that could drag down the Big Banks upon bursting.  The banks had chosen to aggressively go after housing lending, capitalised by issuing offshore debt.  In 2011 rating agencies downgraded the Big Four because of the outsized reliance on foreign borrowings to finance domestic home mortgage lending.  Bank share prices fell in 2011 as a result. By late 2012 and on into 2013 numerous articles cautioned investors about the excessive valuations of the Big Four, despite their impressive dividend payments.  The banks increased their levels of domestic deposits and the housing bubble has yet to burst, although it has been and remains a favored topic in the financial press.

Based on the price performance of the Big Four over the last five years it would appear many investors have ignored the warnings and opted for the attractive dividend payments, until the latest market downturn.  The following table lists the closing share price of the Big Four on 17 September of each year going back to 2011.  All four saw share price declines between 17 September 2010 and 2011.  We also included this year’s highs, reached six months ago for each of the Big Four, and the percentage drop in price since.  Here is the table.

Company

(CODE)

Closing Price 17 Sept 2011

Closing Price 17 Sept 2012

Closing Price 17 Sept 2013

Closing Price 17 Sept 2014

Closing Price 17 Sept 2015

2015 High

% Change

Common-wealth Bank of Australia
(CBA)

$33.19

$44.09

$63.31

$71.68

$75.59

$96.38

(20 March)

-21.5%

Westpac Banking Corporation
(WBC)

$13.99

$19.07

$27.74

$30.42

$31.35

$39.89

(25 March)

-21.4%

Australia &
New
Zealand Banking
Group
(ANZ)

$14.29

$19.32

$26.39

$29.04

$28.18

$37.20

(25 March)

-24.2%

National Australia
Bank
Limited
(NAB)

$15.54

$19.27

$28.96

$30.09

$30.93

$39.57

(13 April)

-21.8%

 

Once the concerns over the downgrades abated and the banks began to rely less on foreign funding the share prices rose substantially between 2012 and 2015.  If they were indeed overvalued, investors were more than willing to pay the price.  CBA increased 41.6%; WBC rose increased 55.3%; ANZ increased 49.2%; and NAB climbed 49.7%.  These increases are to the current share price, not the 52 week high for 2015.  All have dropped more than 20% from the highs in the last six months.

So does that leave them oversold or are they still “overvalued?”  The next table looks at some valuation metrics favored by most investors – the Price to Earnings (P/E) ratio and the Price to Book (P/B) ratio.  For the P/E we include both the trailing twelve month ratio and the Forward P/E to 2017.  The P/B values are as of the most recent quarter (MRQ).  As you scan the table, keep in mind the current P/E for the Bank Sector is 12.67 and the P/B is 1.34.  For the ASX 200 the average P/E is 15.12 with an average P/B of 1.32. Here is the table.

CODE

P/B

(MRQ)

P/E

(TTM)

Forward P/E

(YE 2017)

5 Year Average P/E

5 Year High P/E

5 Year Low P/E

CBA

2.33

13.93

13.17

14.5

15.69

12.39

WBC

1.96

13.13

12.25

13.5

15.29

9.04

ANZ

1.47

10.8

10.63

13.3

13.64

9.82

NAB

1.49

13.08

15.6

15.32

9.66

 

First, note that all of the banks’ P/E’s are lower than the average for the ASX 200.  While the P/B’s are higher, three of the four are trading at less than two times Book Value, a favorite indicator of most Value Investors.  CBA looks to be “the most expensive” of the four (and has been called the most expensive bank stock in the world) but even here the numbers do not seem particularly outrageous.  

In a low-interest world investors have poured into the bank stocks seeking income and most have been rewarded handsomely.  The question of “value” of any stock boils down to risk and potential.  Does the stock have the potential to reward an investor either through an appreciating share price or consistently rising dividends, or both?  The risks are ever-present – will economic headwinds eclipse the stock’s growth or lead to dividend cuts or even elimination?  

In the past investors appear to have been comfortable with both the risks and the potential as the share price has kept rising.  A recent event may be signaling a sea change in investor sentiment.  It began with the Australian Prudential Regulation Authority (APRA) raising capital requirements for the Big Four Banks.  This prompted all of the Big Banks to issue new shares to raise the necessary capital.  The surprise came with the last capital raise from CBA.  The retail portion of the capital raise failed to raise the expected amount.  What’s more, it missed by a lot, raising only $1.5 billion, half of what was anticipated.  CBA went on to raise the extra $1.5 billion through a retail bookbuild, just completed.

Conventional wisdom is that retail investors are now very concerned about the growth potential of the Big Four given the gloomy economic conditions here and around the world, most notably in China.  If our economy does slip into recession, bad loans are likely to increase, eating into bank profits.  Some analysts have claimed the skyrocketing share prices of the Big Four were a result of the “herd” of investors stampeding forward for dividend yield.  If the herd is growing cautious, or reversing direction, that is an indicator few contrarian investors can resist.

So far analysts are not jumping ship.  The following table summarizes analyst ratings on the Big Four from Reuters, updated on 17 September.  The table lists current recommendation with the recommendations from 3 months ago in brackets {}. 

CODE

Consensus

Buy

Outperform

Hold

Underperform

Sell

CBA

Hold

3 {1}

3 {3}

8 {10}

3 {1}

1 {3}

WBC

Outperform

4 {3}

9 {4}

4 {8}

1 {2}

1 {2}

ANZ

Hold

2 {2}

9 {8}

5 {4}

2 {4}

1 {1}

NAB

Hold

2 {3}

3 {4}

12 {9}

1 {1}

0 {0}

 

With the exception of NAB, the banks have seen a slight shift in a positive direction from analysts with more Buy and Outperform recommendations.  While the failure of CBA’s initial retail offering was not a good sign, in a matter of days following the CBA event, the “herd” may be returning, as the share price has begun rising, as has the price of the other banks.  The following chart tracks the price movement of CBA and WBC over the last five days.

Now here is the chart for ANZ and NAB.  

With the looming possibility of additional RBA rate cuts in the future, investors may be ready to live with the risks to growth to chase that yield.  The following table includes the historical performance of the banks as well as the two earnings and dividend growth forecasts.

CODE

Dividend Yield

2 Year Dividend Growth Forecast

5 Year Dividend Growth Rate

5 Year Earnings Growth Rate

2 Year Earnings Growth Forecast

3 Year Total Shareholder Return

5 Year Total Shareholder Return

CBA

5.6%

+3.7%

+7.7%

+7.7%

+6.2%

+16.6%

+14.4%

WBC

5.9%

+2.6%

+9.4%

+14.9%

+1.8%

+14.6%

+13.2%

ANZ

6.4%

+1.9%

+11.8%

+9.5%

+0.2%

+10.3%

+9.8%

NAB

6.4%

+0.8%

+6.3%

+2.5%

+11.6%

+13.9%

+11.4%

 

There is no argument that the banks have not performed very well over the past five years, despite the warnings at various points in time.  While the earnings growth forecasts in the table are moderate to minimal, there are market commentators and analysts out there who feel the dividends are safe, at least in the near term.  Payout ratios range from a low of 64% at ANZ to a high of 93% at NAB.   Of course, there are others claiming there are better places on the ASX in which to put your money.  However, few, if any, can match the income stream the Big Four banks have returned to investors.

Although ANZ has the lowest earnings growth forecast, it has the most growth potential of any of the banks due to its “Super Regional” Strategy, launched in 2007 to expand into Asian markets.  You would be hard pressed to find anyone who does not point to concerns about a slowdown in China as a major contributing factor to the current market volatility.  This could be the best explanation for ANZ having the worst share price performance among the Big Four.   ANZ recently signed a deal with IBM to provide technology needed to promote the Asian strategy.  With a P/E of 10.8 and a P/B of 1.47 it seems a stretch to characterize this stock as overvalued.  In addition, ANZ has the highest current yield and the lowest payout ratio.

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