Monday 14th November 2016
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Unlike Commonwealth Bank of Australia and Westpac Banking Corporation, which are already operating at close to optimum levels, National Australia Bank and ANZ Banking Group have been weighed down by problematic exposures to regions and markets that have been generating a sub-par return (and in some instances actual losses). However, it has been their ability to address these shortcomings during a period when top-line growth is limited that is now resonating with investors.
Case in point is ANZ Banking Group’s latest full-year results, which featured a headline statutory profit of $5.7 billion that represents a 24 percent decline on the previous corresponding period. While this is obviously not an ideal outcome for shareholders, after stripping back the layers, we view ANZ Banking Group’s FY16 results as a necessary stepping stone to improved and more sustainable earnings down the track.
From our perspective, the broad drivers of ANZ Banking Group’s FY16 results comprised (i) a good performance from the bank’s domestic businesses, and (ii) the significant reshaping of the bank’s institutional business, with a particular focus on low yielding assets and improved productivity in Asia. This of course is not dissimilar to what National Australia Bank is seeking to achieve by selling low returning assets to create a simpler, better capitalised and more balanced bank.
Adjusting for the $1.1 billion of specified items that were reported in FY16, we note that ANZ Banking Group’s underling performance through the period was not nearly as bad as the headline numbers suggest. While ANZ Banking Group still reported a 2.5 percent decline in pro-forma FY16 profit, this represents a marked improvement on the 18 percent decline in cash profit and 24 percent decline in statutory profit.
The other key point to note about ANZ Banking Group’s FY16 results is that while the bank’s cash profit was lower during the period, the impact that this had on net capital generation was negligible. This was due largely to credit risk-weighted asset reductions (excluding foreign exchange impacts) of $12 billion in ANZ Banking Group’s institutional business. This of course adds support to ANZ Banking Group’s CET1 ratio and ability to distribute 60-65 percent of cash earnings as dividends.
While it seems reasonable to expect management’s transformation plans for ANZ Banking Group to crimp near-term earnings, we expect the strategy to ultimately pay dividends for shareholders. Not unlike National Australia Bank, we expect ANZ Banking Group’s decision to optimise its operating structure and credit exposures to deliver incremental gains in ROE over the next several years, with this likely to translate to a higher per share metrics (i.e. book value and earnings multiple).
Based on consensus earnings estimates for FY17, ANZ Banking Group is trading on 11.7 times and offering a dividend yield of 5.9 percent. While noting the near-term earnings risks, we view the implied payout ratio as comfortable. Furthermore, we note that ANZ Banking Group’s overall investment case is supported by the stock’s technical set-up, with our analysis suggesting the recent share price gains will continue to press on toward a confluence of resistance at $29.80 per share.
We believe that the near-term risks associated with ANZ Banking Group’s exposure to the Asian region have been factored in to the bank’s share price. Furthermore, on a medium-term view, we believe that ANZ Banking Group’s future growth prospects are arguably superior to its major peers, with this based on the view that the bank has a strong competitive position in Australia and New Zealand and an early mover advantage and more recently optimised exposure to Asia.
James Lennon is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE
Disclosure: ANZ is held in the Fat Prophets Concentrated Australian Share and Australian Share Income models.
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