More brokers are upgrading bank-stock recommendations as revelations of misconduct weigh on valuations and create opportunity for long-term investors.
Another way to play the fallout from the financial-services Royal Commission is through sectors and companies that benefit from banking’s problems. More on that later.
These strategies suit different investors. Income seekers should pay extra attention to ANZ and National Australia Bank after their half-year reports this week, and to Westpac on Monday. They should also look closely at Commonwealth Bank.
The four big banks have fallen 15-20 per cent from their 52-week high. At the current price, each trades at least 10% below the consensus share-price target from broking firms.
On a grossed-up basis (after franking credits), the big banks are yielding around 9%. Expected dividend yield should provide some price support for bank stocks at these levels, especially if the half-year reports (still to come as this column is written) show the market is too bearish.
Make no mistake: the banks are not a screaming buy. The fallout from the Royal Commission is more widespread than the market expected and will spark numerous shareholder class actions and other lawsuits. Extra regulation or enforcement that weighs on bank growth is inevitable.
But the question is whether this outlook is already captured in bank valuations. Australia’s economy is improving, bank margins are stable, credit-quality trends are benign and bank capital positions have strengthened. It is hard to see a housing crash and spike in bad debts that will crunch the banks anytime soon, as some bears have long predicted.
Rising offshore funding costs are an issue but the banks should be able to lift mortgage rates slightly and offset margin pressures. Also, the big banks have scope for share buybacks or other capital-management initiatives to help support their stock price.
The main problem is the lack of catalysts to re-rate bank stocks this year. In a low credit-growth environment, and with the risk of higher compliance costs after the Royal Commission, it’s hard to see banks trumping the market’s growth expectations. Yield is the main attraction.
On Macquarie’s numbers, the bank sector is trading at a 33% discount to the industrial sector versus a long-term average of 22%. The sector arguably warrants a bigger discount than usual given the gravity of its problems, but the market may have over-reacted at current prices.
As hard as it is, buying during bouts of bad news and excessive market reaction is invariably the best strategy for long-term portfolio investors. Yield-focused investors who rely on bank stocks for income could add to sector allocations at these levels.
Those seeking to position for a short-term rally in bank stocks could “buy the sector” through the BetaShares S&P/ASX 200 Financial Services ETF, the VanEck Australian Banks ETF or State Street’s SPDR S&P/ASX 200 Financials EX A-REIT Fund.
Winners from bank fallout
The second strategy – focusing on sectors and stocks that will benefit from deteriorating sentiment towards the banks – suits growth investors who are comfortable with higher-risk small- or micro-cap stocks. This is more of a tactical play for active investors.
I see three potential sector winners from the Royal Commission. Of course, the Commission – and its eventual impact on bank regulation, compliance and sentiment – is one of many factors that play into valuations. But it could create another tailwind for pockets of market activity.
The first winners are litigation funders and listed law stocks. As always, the big winners from Royal Commissions or regulatory reviews are lawyers and firms that fund successful cases.
AMP alone is facing a fourth potential shareholder class action amid allegations that the wealth-management firm misled investors and breached its continuous-disclosure obligations.
The Royal Commission will create years of work for law firms representing shareholders and stakeholders affected by banking misconduct. The big litigation funders will have plenty of class actions to fund and presumably good odds of favourable verdicts or early settlements.
IMF Bentham is this market’s highest-quality litigation funder and a solid performer over the past decade. IMF is down this year after a strong rally in 2017. That looks like an opportunity for investors who can see the potential in IMF funding class actions against the banks and wealth managers. IMF announced this week it will fund an action against AMP.
I struggle to write favourably about Slater + Gordon or other listed law stocks after all their problems, and high-profile class actions often do more for the firm’s profile than its profitability. I’ll stick with the litigation funders as the best way to play the trend.
Chart 1: IMF BenthamSource: ASX
The banks’ tarnished reputations are bad news for the sector and good news for media companies that will benefit as banks advertise more to rebuild brands. Some broking analysts have already identified an increase in bank advertising this year.
It would be foolish to buy media stocks based on a pick-up in bank advertising alone. Traditional media companies will need a lot more than great bank marketing to offset their declining advertising base. But this is an important advertising segment for the media sector and banks have years of marketing work ahead to lift their brand equity.
Outdoor advertising group oOH! Media is an interesting way to play the trend. oOH! Media is benefiting from faster growth in out-of-home advertising compared to the broader media sector. Digitisation of outdoor and indoor ads is boosting advertising yields.
One can envisage banks increasing their advertising spend in the next few years, and the mix of outdoor advertising within it, as part of a sector effort to repair public trust. oOH! Media looks well placed to benefit and can continue to grow with or without a lift in bank advertising.
Chart 2: oOH! MediaSource: ASX
Financial technology (fintech) companies must be salivating at the prospect of taking market share from the big banks. The Royal Commission will surely slow the big banks down by adding extra compliance and costs, at a time when they need to be more nimble and aggressive to combat the fintech threat (and benefit from financial technology).
Peer-to-peer lending stocks could benefit if more borrowers look to bypass the banks, but most on ASX are too small and speculative for portfolio investors. Big fintech payment providers, such as Afterpay Touch Group, are a better bet but look fully valued after recent price gains.
Hub24 is another option. The company provides an investment platform and licensing solution for financial advisers through subsidiary Paragem. Hub 24’s investment and superannuation platforms are aimed at financial advisers and investors.
The repercussions of the Royal Commission on the banking and financial-planning sectors should benefit Hub24 in the long run.
Hub24 said at its Annual General Meeting in November 2017: “Across Australia, an increasing number of advisers are choosing to become self-licensed or join more flexible dealer groups as they move away from institutionally owned licensing models … our group is well placed to capitalise on this trend with advice businesses seeking greater choice, transparency and engagement with new technology platforms.”
This trend towards adviser independence is hardly new but has a long way to run. More investors will seek independent financial advice after Royal Commission revelations about practices at some financial-planning groups. That should be good for Hub24.
The main issue is valuation. Hub24 has soared from a 52-week low of $4.82 to $11.08. A consensus price target of $11.09, based on five broking firms (too small to rely on), suggests the stock is fully valued. Tech stock is priced for perfection, trading on a forward Price Earnings (PE) ratio of 55 times FY19 on some broker estimates.
Hub24 is so far delivering, with strong growth in funds under administration and financial advisers using its platform. Share-price gains will be slower from here, but the stock has a good long-term growth outlook as more financial advisers change dealer groups and as more Australians seek independent financial advice after the Royal Commission.
Portfolio investors might watch and wait for better value as some steam inevitably comes out of Hub24’s share price after recent strong gains.
Chart 3: Hub24Source: ASX
• Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article you should consider the appropriateness and accuracy of the information, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at May 1, 2018.