Major bank share prices have climbed 26 per cent since November, supported by the measures they have taken to protect margins alongside global funds increasing ownership and inflows into passive funds.
In its analysis of Australian banks, Morningstar said while ANZ and Westpac are reasonably priced among the big four Australian banks, the premium on Commonwealth Bank is “puzzling” and NAB is overvalued.
Describing them as the cheapest majors, Nathan Zaia, Morningstar equity analyst, said ANZ and Westpac are “modestly undervalued” compared to their peer Commonwealth Bank which is “expensive”.
ANZ closed on 15 July at $29.79 while Westpac was modestly lower at $28.08. Commonwealth Bank, on the other hand, closed at $132.36.
“The valuation divergence for Commonwealth Bank and peers ANZ Bank and Westpac is stark, and in our view, unjustified,” said Zaia.
“Price/book discounts could unwind as ANZ Bank and Westpac hold market share and deliver similar earnings growth but on a cheaper PE,” he said.
Delving deeper into Westpac and ANZ, Zaia said the funding cost advantages wide-moat-rated Westpac enjoys will likely see a return to strong profits and returns on equity over time.
“Customer remediation, uplifting risk management and digital investment, and divesting nonbank businesses were costly and distracting. Not only did operating expenses rise as revenue was under pressure, but loan approval times were slow,” he said.
“Loan approval times, and loan growth, have already improved, but a cost rebasing takes time.”
On ANZ, he noted process investments should make the wide-moat bank more competitive in home lending after it lost material home loan market share.
“While this comes with added costs, it should help drive earnings growth and returns on equity,” Zaia said.
ANZ’s acquisition of Suncorp Bank, which was greenlit by the Australian Competition Tribunal in February, and more recently approved by Treasurer Jim Chalmers, could “improve bank efficiency modestly”. However, Zaia cautioned that the drawn-out integration and associated costs make it unlikely to be materially value accretive.
“Some acquisitions in the past failed to extract cost savings and contributed to customer service issues, which are risks for ANZ Bank,” he said.
Meanwhile, on Commonwealth Bank, Zaia said “valuation metrics leave little room for disappointment”.
“The share price strength is at odds with our three-year EPS growth forecast of 4 per cent per year.”
According to Zaia, the best value is in non-majors.
“Weaker share price performance for most non-majors sees their yields at more attractive levels than the majors,” he said.
“We think the non-majors margin risk is more than reflected in their prices.”
Namely, he noted the major banks’ weighted average price/fair value estimate is 1.19 versus 1.14 last quarter while non-major banks trade at 0.97.
“Non-major bank margins are squeezed by intense competition, but we expect improvement as major banks prioritise returns,” he said.
Zaia noted that non-majors need deposit and mortgage rate pressures to ease.
His top value picks among the non-major banks include Bank of Queensland, which could see a recovery in medium-term earnings driven by net interest margin improvement “as industry competitive pressures ease and the bank extracts cost savings from consolidating banking platforms and digitising more processes”.
Similarly, he said, MyState, which holds a modest 0.3 per cent share of the home loan market, has demonstrated an ability to profitably grow loans with investments in an expanded sales team and its digital products.
