I. Sector Landscape and Outlook

Australia's financial services sector had significant resilience and contribution in fast-paced recoveries witnessed in Australian Markets. In 2020, financial and insurance services contributed 9.4% to total Gross Value Added (GVA) and grew by a 4.2% CAGR (FY1990 – FY2020) concerning real gross value added. Assets of Authorized Deposit-taking Institutions (ADIs) and Registered Financial Corporations (RFCs) have manifested consistent and sustainable growth with a 9.7% CAGR (FY2000 – FY2020).

Figure 1: Broad Indicators of the Financial Services Sector:

Source: Analysis by Kalkine Group

In the latest release by the Australian Bureau of Statistics (ABS), Australia’s Gross Domestic Product (GDP) improved by 1.8% in March 2021 quarter due to easing containment restrictions and considerable recoveries in the labour market. Household expenditure heightened by 1.2% in the March quarter, primarily driven by growth in spending on services as cafes & restaurants, recreation & culture, hotels, and transport services. In a separate release, households’ net lending position improved to $40.0 billion on account of increased deposits and net equity in pension funds and loan borrowings. As detailed below, household savings have declined to 11.6% in the March 2021 quarter (QoQ), implying the resurgence in spending because of transition of the economy to pre-COVID levels.

Figure 2: Rebound in Household Spending:

Source: Australian Bureau of Statistics, Analysis by Kalkine Group

With the revival of private capital expenditure, in consequence of favorable and financial support, Australia is set to outreach pre-COVID levels. The total new capital expenditure has increased by an astounding 6.3% in March 2021 quarter, stood at $31.5 billion. Liabilities on private non-financial corporations increased by $12.9 billion, while debt-to-equity ratio declined from 0.52x to 0.48x.

Figure 3: Declining D/E Ratio Amidst Favorable Government Measures for Raising Equity

Source: Australian Bureau of Statistics, Analysis by Kalkine Group

Lending activities have increased since the Reserve Bank of Australia (RBA) and the government's relief measures for households and businesses. Total residents’ loans and finance leases inclined by 2% ($6.0 billion) in April 2021, and owner-occupied loans rose by 0.3% ($2.1 billion) due to strong lending and borrowing activities underpinned by low mortgage interest rates. Long-term borrowings by ADIs reported a seventh consecutive decline reaching $498 billion in April 2021 as ADIs continue to access to RBA's Term Funding Facility. Issuance of certificate of deposits reached pre-COVID levels to tie-over the short-term funding requirements by corporates.

Figure 4: Declining Long-Term Borrowings Compensated by Improving Short Term Borrowings:

Source: Australian Prudential Regulation Authority, Analysis by kalkine Group

Despite a marginal decline in asset quality in recent months, banks have recovered their profitability metrics with generous funding and liquidity. CET1 capital ratios improved by ~$16.9 billion (+100bps), attributed to improved profitability in the banking system and NAB’s ~$4.25 billion in capital issuance. With the Term Funding Facility (TFF) introduction, banks' funding costs have curtailed, and liquidity has spiked. In April 2021, ARPA reported that deposits from households and non-financial businesses elevated by 0.3% ($3.7 billion) and 0.3% ($2.4 billion), respectively.

Figure 5: Deposits Have Trended Upward Post COVID-19 Impact:

Source: Australian Prudential Regulation Authority, Analysis by kalkine Group

Australian superannuation funds registered one of the highest growth rates, which places the value of Australian superannuation funds (~$2.3 trillion) as the world's fifth largest. As of 31 March 2020, fund’s total unconsolidated assets inclined by 3.1% (QoQ) and reached $3.19 trillion, predominantly attributed to an upswing in equity shares and overseas investment.

Total unconsolidated assets of life insurance corporates took a nosedive of 1.4% and stood at ~$126.6 billion on the March 2021 quarter on a QoQ basis. In addition, natural catastrophe claims cost increased, predominantly by claims against Halloween hailstorm and Queensland flood events. Despite adverse outcomes, aggressive capital raising strategies improved the industry PCA coverage ratio to 1.71x in the year ended 31 March 2021 relative to 1.66x in the prior year as shown in the below chart.

Figure 6: Catastrophes Surround Capital Coverage Ratios:

Source: Insurance Council of Australia, Analysis by Kalkine Group

Index Performance:

The ASX 200 Financials (GIC) Index has generated a 1-year return of ~38.02% as compared to ~22.82% by the ASX 200 Index. Revival in household spending, resurgence in capital expenditure by corporates, improving household wealth, and record low mortgage rates driving housing loan commitments are some of the supporting factors driving the sector gains.

Figure 7: The ASX 200 Financials Index outperformed the ASX 200 Index in the past one year by whooping ~15.20%:

Source: REFINITIV as on the close of 17 June 2021

Key Risks and Challenges:

Consumer confidence is yet to restore as credit card lending remains ~20% below pre-COVID levels. As the economy looms towards recovery, funding access by businesses dropped. On 3 May 2021, the Insurance Council of Australia (ICA) announced relief for dissatisfied policyholders with a provision to escalate complaints with claims up to ~$1.085 million, exerting a burden to the industry. The $36 billion outflows from superannuation funds concerning COVID-19's early may obstruct the funds’ long-term operations. Financial operations in a low-interest-rate environment may present repricing risk to the insurance industry subjected to the increased discounted value of insurers' future liabilities.

Figure 8: Key Risks and Challenges in the Financial Services Sector:

Source: Analysis by Kalkine Group

Outlook:

Outlook for business lending activities stood positive due to the economy approaching expansion phase, prompt government policies & measures and proliferated business confidence. As per the FY22 budget, the government proposed a $7.8 billion tax relief for low-income earners to stimulate consumption and approach the expansion phase. In addition, an extension of temporary full expensing and temporary loss carry-back schemes may provide additional tax relief of $20.7 billion to support business investment and employment. According to the Australian Industry Group, Australian PMI improved to 61.8 points in May 2021, the highest monthly PMI recorded since March 2018, indicating recovery in the economy.  

II. Investment theme and stocks under discussion (ASX, LFS, IAG, KSL)

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: ASX (ASX Limited)

(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$14.69 billion)

ASX is involved in providing securities and derivative exchange, central counterparty clearing services, ancillary services, settlement, depository, and other financial services.

Valuation

Our illustrative valuation model suggests that stock has a potential upside of ­­­­­­22.30% on 17 June 2021. We believe that the stock might trade at a slight premium compared to its peer average Price/Book Value (NTM trading multiple) given investments in volume-driven hardware improvements, positive sentiments for trading volume and higher Austraclear performance expectations. For the said purposes, we have taken peers such as EQT Holdings Ltd (ASX: EQT), Perpetual Ltd (ASX: PPT), Macquarie Group Ltd (ASX: MQG), to name a few. Considering the volume growth in equity markets, outperformance in H1FY21 and FY20, top-line growth in all segments, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $75.960, up by ~0.039% on 17 June 2021. In addition, the stock has delivered an annualised dividend yield of 3.09%.

2. ASX: LFS (Latitude Group Holdings Limited)

(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$2.30 billion)

LFS is involved in instalments and lending business covering Australia and New Zealand. The company offers personal loans, credit cards, and vehicle loans.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 23.62% on 17 June 2021. We believe that the stock might trade at some premium as compared to its peer average Price/Book Value (NTM trading multiple) given guidance for substantial growth in NPAT, improving volumes across Australia and New Zealand and favourable top-line momentum. For the said purposes, we have taken peers such as Credit Corp Group Ltd (ASX: CCP), Zip Co Ltd (ASX: ZIP), Eclipx Group Ltd (ASX: ECX), to name a few. Considering the volume recovery in all business areas, the launch of LatitudePay+, volume growth expectations from border reopening, valuation, and trading levels, we give a “Speculative Buy” recommendation on the stock at the current market price of $2.310, up by ~0.434% on 17 June 2021.

3. ASX: IAG (Insurance Australia Group Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$12.74 billion)

IAG is a group entity which is involved in insurance business in Australia and New Zealand.

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of 13.13% on 17 June 2021. We believe that the stock might trade at a slight discount as compared to its peer average Price/Book Value (NTM trading multiple) given higher perils allowance, portfolio exposure to high credit risk and associated insurance risks. For the said purposes, we have taken peers such as Suncorp Group Ltd. (ASX: SUN), QBE Insurance Group Ltd. (ASX: QBE), Steadfast Group Ltd. (ASX: SDF), to name a few. Considering the launch of the first tranche of IAG’s personal lines products, significant improvements in GWP, maintained cost levels, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $5.220, up by ~0.967% on 17 June 2021. The stock has delivered an annualised dividend yield of 3.25%.

4. ASX: KSL (Kina Securities Limited)

(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$308.45 million)

KSL is engaged in commercial banking and financial services.

                                                                                                        

Valuation

Our illustrative valuation model suggests that the stock has a potential upside of ­­­­­­18.28% on 17 June 2021. We believe that the stock might trade at some discount as compared to its peer median Price/Book Value (NTM Trading multiple) given high currency risks subject to international operations, low-interest rates, and high credit risk in the commercial banking segment. For the said purposes, we have taken peers such as Pacific Current Group Ltd (ASX: PAC), Genworth Mortgage Insurance Australia Ltd (ASX: GMA), Humm Group Ltd (ASX: HUM). Considering improvements in net interest income, sustainable cost structure, sufficient liquidity, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $1.060, down by ~1.396% on 17 June 2021. The stock has delivered an annualised dividend yield of 8.01%.

Note: All the recommendations and the calculations are based on the closing price of 17 June 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.  

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.

---

Disclaimer - This report has been issued by Kalkine Pty Limited (ABN 34 154 808 312) (Australian financial services licence number 425376) (“Kalkine”) and prepared by Kalkine and its related bodies corporate authorised to provide general financial product advice. Kalkine.com.au and associated pages are published by Kalkine.

Any advice provided in this report is general advice only and does not take into account your objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your objectives, financial situation and needs before acting upon it.

There may be a Product Disclosure Statement, Information Statement or other offer document for the securities or other financial products referred to in Kalkine reports. You should obtain a copy of the relevant Product Disclosure Statement, Information Statement or offer document and consider the statement or document before making any decision about whether to acquire the security or product.

You should also seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice in this report or on the Kalkine website. Not all investments are appropriate for all people.

The information in this report and on the Kalkine website has been prepared from a wide variety of sources, which Kalkine, to the best of its knowledge and belief, considers accurate. Kalkine has made every effort to ensure the reliability of information contained in its reports, newsletters and websites. All information represents our views at the date of publication and may change without notice.

Kalkine does not guarantee the performance of, or returns on, any investment. To the extent permitted by law, Kalkine excludes all liability for any loss or damage arising from the use of this report, the Kalkine website and any information published on the Kalkine website (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine hereby limits its liability, to the extent permitted by law, to the resupply of services.

Please also read our Terms & Conditions and Financial Services Guide for further information.

On the date of publishing this report (referred to on the Kalkine website), employees and/or associates of Kalkine do not hold interests in any of the securities or other financial products covered on the Kalkine website.