I. Sector Landscape and Outlook
The Banking and Financial Services represent asset-based financing, leasing, funds management, hedge funds, insurance, investment banking, payment systems, private equity/ venture capital, and retail banking activities. The Banking and Financial Services industry in Australia is the third-largest recipient of foreign direct investment with $113.2 billion received in 2019, according to the Department of Foreign Affairs and Trade. The asset size of Authorized Deposit-taking Institutions (ADIs), managed funds, and the Reserve Bank of Australia grew at a healthy pace of +9.2% over the past ten years to reach $10 trillion in 2019-20. This sector is one of the largest contributors to the economy with 8.1% of Gross Domestic Product (GDP) in the December 2020 quarter.
Australia has the highest average household wealth per adult population (of US $419,460) in 2019, according to a report by Credit Suisse. Due to this, the nation boasts the fifth largest pension system in the world with pension assets of US $2.33 trillion in 2019-20, according to the Australian Trade and Investment Commission. The Banking and Financial Services industry is dominated by deposit-taking institutions and pension funds, which together represent ~87% of total assets as of June 2020. Insurance topped in the third place with the combined assets of $328 billion, according to the data by the Reserve Bank of Australia.
Figure 1. Asset-wise Split in The Banking and Financial Services Sector:
Data Source: The Reserve Bank of Australian, Chart Created by Kalkine Group
Credit growth has been trending down following a sharp increase during the peak of the pandemic. The trend indicates businesses repaying credit lines that were drawn during March and April 2020 to boost liquidity in troubled times. Due to uncertainty, businesses were reluctant to take new loans. Further, businesses made use of a range of temporary government schemes and loan deferral initiatives to sail through the pandemic.
Housing loans took the lead fuelled by the government’s The HomeBuilder Scheme and rising prices of residential dwellings. A decline in the outstanding limit of credit cards indicates households either lost their appetite or keen on repaying their debt during the pandemic. Households took the benefits of the early access to the superannuation scheme to pay their dues. A recent survey by the Australian Bureau of Statistics mentioned that about 29% of respondents utilized the scheme towards mortgage payments, 27% towards household bills, and 15% to repay credit cards. According to the recent data by the Commonwealth Bank, debit card and credit card spending by Australians has increased by 12% for the week ended February 5, 2021.
In the chart below, credit growth moderated to 1.57% in February 2021 over the prior year to reach $3.025 trillion. On the contrary, the money circulation in the economy has been increasing steadily, denoted by The Broad Money. The government’s various support programs encouraged households to spend expensively.
Figure 2. The Government Stimulus Helped to Increase Money Supply:
Data Source: The Reserve Bank of Australian, Chart Created by Kalkine Group
Many ADIs were granted temporary relief to borrowers during the pandemic. The share of deferral loans peaked during the initial period. The ease of restrictions, improvement in consumer confidence, favorable employment growth, and government support programs helped households to lower deferrals loans. According to the Australian Prudential Regulation Authority, exits from deferrals continue to outweigh the entries into deferral schemes in recent times. Victoria has the highest proportion of loan deferrals. Housing loans make up most of the loan deferrals. Most small-medium enterprises (SMEs) took advantage of loan deferrals. The ensuing conditions in business sentiments enabled a handful of SMEs to resume repayments.
Figure 3. Share of Deferral Loans Reached Just 0.5% in February 2021:
Data Source: Australian Prudential Regulation Authority, Chart Created by Kalkine Group
Superannuation funds saw a blow in inflows during the pandemic led by unemployment and a low-interest rate regime. The pandemic crippled the global financial market and retirement savings were suffered by a fall in the value of listed and unlisted assets. The early release scheme by the government has put liquidity pressure on funds. Allocation to cash assets was increased to address the redemption. Successful virus containment measures following the easing of restrictions helped the funds to post annualized returns of 6.8% in the last ten years for the period ending June 2020. The recovery of financial markets in the second half helped to win the fund inflows. Assets of superannuation funds have been increasing since June 2020 reaching $3.09 trillion in the December 2020 quarter, according to the Australian Bureau of Statistics. Total managed funds in Australia increased by 4.4% to $4.00 trillion (on a QoQ basis). Net contribution flows to superannuation funds turned positive to $7.7 billion in December 2020 quarter.
Figure 4. Superannuation Funds Showing Recovery:
Data Source: Australian Bureau of Statistics, Chart Created by Kalkine Group
Index Performance:
The ASX 200 Financials (GIC) Index generated a 1-year return of ~47.74% as compared to ~31.42% by the ASX 200 Index. Accommodative policy stance by the Reserve Bank of Australia, active bond purchase program to revive growth, increasing household wealth creation, and resilient performance by superannuation funds are some of the factors that helped to post sector gains.
Figure 5: The ASX 200 Financials (GIC) outperformed ASX 200 Index by whooping ~16.32% in one year period:
Source: Refinitiv (Thomson Reuters) as on the close of 29 April 2021
Key Risks and Challenges:
The asset quality has been deteriorating and the loan deferral program has dampened the levels of impaired assets in the banking system. In the recent data by the Australian Prudential Regulation Authority, impairment of assets surged 17.1% to reach $36.4 billion as of December 2020 and provisions also posted an increase of 13.2% to $14.6 billion. Low mortgage rates and weak lending standards may collapse the banking system. The debt-to-income ratio of households over six times has increased by 26.3% and the loan-to-value ratio of over 95% has surged 27.4% in December 2020 (YoY basis). This may erode household wealth as households already relied upon government support programs to fund their bills and to make mortgage payments. Expiry of the JobsKeeper program may dent the financial resources of households.
Figure 6. Key Risks in the Banking and Financial Services Sector:
Sources: Analysis by Kalkine Group
Outlook:
As set out in the budget 2020-21, the government is set to close underperforming super funds to protect retirement earnings of households and to reduce fees paid by them. It also aims to increase accountability and transparency of funds. Through these reforms, the government is confident of saving $17.9 billion over the next decade. The Reserve Bank of Australia is expecting a GDP growth of 3.5% in each of 2021 and 2022. The unemployment rate may continue to slide reaching 5.5% in 2022 and 5.25% in mid-2023. Inflation and wage growth are expected to remain below 2% till mid-2023. The accommodative policy stance supported the balance sheets of banks and lifted asset prices. In the recent policy meet, the board of the Reserve Bank of Australia has decided to purchase an additional $100 billion of bonds issued by the government which is expected to spur the economic recovery and achieve faster credit transmission.
II. Investment theme and stocks under discussion (CGF, NGI, ANZ, NAB))
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘Price/Book Value’ method.
1. ASX: CGF (Challenger Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$3.40 Billion)
CGF is an investment management company and is engaged in the business of financial services. Challenger Life is the largest player in the annuities space in Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 24.81% on 29 April 2021. We believe that the stock might trade at a slight discount compared to its peer median Price/Book Value (NTM Trading multiple) considering its significant exposure to market risk, which resulted in erosion of profitability in FY20. The low-interest rate and softening of yields to continue to linger around profitability. For the said purposes, we have taken peers such as AMP Ltd. (ASX: AMP), Omni Bridgeway Ltd. (ASX: OBL), Earlypay Ltd. (ASX: EPY). The stock has delivered an annualized dividend yield of 5.27%.
2. ASX: NGI (Navigator Global Investments Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$319.20 Million)
NGI is a holding company that operates in the asset management business. It provides alternative asset management and services to institutional investors.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 21.07% on 29 April 2021. We believe that the stock might trade at a slight discount compared to its peer median Price/Book Value (NTM Trading multiple), citing the volatility in global markets and fund outflows have a weight on the revenue model of the company. For the said purposes, we have taken peers such as Perpetual Ltd. (ASX: PPT), Pacific Current Group Ltd. (ASX: PAC), Moelis Australia Ltd. (ASX: MOE). The stock has delivered an annualized dividend yield of 7.73%.
3. ASX: ANZ (Australia and New Zealand Banking GrpLtd)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$82.80 Billion)
ANZ provides checking, savings deposits, money market, mortgage, and term loans services, as well as card facilities and Internet banking services. It caters to customers in New Zealand and Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 16.19% on 29 April 2021. We believe that the stock might trade at a slight premium compared to its peer average Price/Book Value (NTM Trading multiple) given the strong leadership in the home loan portfolio in Australia and New Zealand market and solid capitalisation. For the said purposes, we have taken peers such as Bendigo and Adelaide Bank Ltd. (ASX: BEN), National Australia Bank Ltd. (ASX: NAB), Commonwealth Bank of Australia (ASX: CBA). The stock has delivered an annualized dividend yield of 2.07%.
4. ASX: NAB (National Australia Bank Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$88.76 Billion)
NAB offers banking and financial services with operations spread across Australia and New Zealand, Asia, the UK, and the US serving 9 million customers.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 17.08% on 29 April 2021. We believe that the stock might trade at a slight discount compared to its peer Price/Book Value (NTM Trading multiple) on the concerns of deterioration in asset quality which may inflate provisioning and affect profitability. The capital requirements may also need to be increased to reflect the rise of risky assets. For the said purposes, we have taken peers such as Australia and New Zealand Banking Group Ltd. (ASX: ANZ), Bendigo and Adelaide Bank Ltd. (ASX: BEN), Bank of Queensland Ltd. (ASX: BOQ). The stock has delivered an annualized dividend yield of 2.24%.
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Note: All the recommendations and the calculations are based on the closing price of 29 April 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.
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