Westpac, NAB and ANZ have reported their annual results for the year ending 30th September 2024 and they all show that profit margins are under pressure and, despite nominal bad debts, profit growth remains elusive. How then to explain the record valuations of this group, not to mention CBA which is the most expensive bank in the world.
With franking credits on top, that might be enough for you. But that assumes everything goes right, and pesky concerns about expensive acquisitions, new chief executives, risky and expensive IT projects, falling margins, brokers reducing the profitability of mortgages, bad debts that can't get any lower, and increasing competition remain dormant.
The best excuse is that they're not directly exposed to China. But whether you weigh each bank's return on equity against its book value, or you forecast earnings for a price-to-earnings ratio (PER) and dividend yield, the group will be lucky to produce a 5% annual return over the next decade.
Westpac
CEO Peter King announced he'll retire in December and be replaced by Institutional Bank head Anthony Miller, who's been with the bank since 2020. Miller has potentially inherited a poisoned chalice, with earnings falling 3% and a huge, expensive IT project that belies Westpac's lofty PER of 16 and 5.2% fully franked dividend yield.
A 9.7% return on equity suggests the share price must fall by at least a third to produce a 10% annual return, assuming steady profits. We've slightly increased the prices in our recommendation guide, but don't expect material growth in earnings or dividends. HOLD.
NAB
National Australia's result also showed the intensity of competition for mortgages with profit falling 8% to $7.1bn and rising bad debts, albeit from low levels. Cash earnings from the retail bank fell nearly 20% to $1.8bn, with only the bank's largest division — Business and Private Banking — able to hold profits flat.
National Australia deserves its premium over Westpac, but it's absurdly priced with a PER of 18, 4.2% fully franked dividend yield and an 11.6% return on equity that suggests the share price must fall 40% to produce a 10% return.
Like Westpac, investors shouldn't expect much more than a 5% annual total return, though we're bumping up the prices in the recommendation guide given the bank's increased profitability in recent years under former boss Ross McEwan. SELL.
ANZ
ANZ's result paralleled its two larger rivals. Earnings fell 8% to $6.7bn with margins squeezed by intense competition for mortgages and deposits. Bad debts remain low yet total dividends for the year fell from $1.75 to $1.66 for a partly-franked 5.2% dividend yield.
ANZ's PER of 14 is the lowest of the big four as it continually hurts shareholders with lousy acquisitions, which is why it's our least preferred bank. We don't expect much earnings growth, if any, and its 9.7% return on equity suggests the share price must fall nearly 30% for a 10% return assuming the Suncorp acquisition isn't a disaster. HOLD (just).
Commonwealth Bank
For completeness, CBA's share price has increased 6% since we downgraded it to Sell following its annual result. Valuation aside, it's our favoured bank as it's the gorilla in a game of scale and imposes its advantages rather than waste time and money on acquisitions.
It currently trades on a farcical PER of 26 and a paltry 3.1% fully franked dividend yield. Its return on equity of 13.6% suggests the share price must fall by over 60% to produce a 10% return, which is why it remains a Sell despite us slightly increasing the Buy price. SELL.
Summary
Normally crazy valuations are reserved for growth stocks at the tail end of a long bull market, particularly those with new technology. The banks are the opposite, which is why we've increased their share price risk ratings to High.
For context, Warren Buffett has been selling Bank of America which has similar profitability metrics to ANZ and Westpac, yet trades on a PER of 14 with profits expected to increase 10%.
JP Morgan is considered the world's best bank, boasting a return on equity of nearly 16%, well above CBA with similar earnings growth. Yet its PER is nearly half CBA's.
The implications of recent results and current bank valuations are clear. Profits are under increasing pressure and can't support rapidly growing dividends or justify current valuations. But that doesn't mean share prices can't keep increasing in an environment where valuations don't matter.
If your focus isn't on valuations, you can ignore our price guides. Just be prepared for large share price falls and don't expect capital gains or growing dividends unless the banks can arrest falling profit margins.
For everyone else, you're unlikely to get a better opportunity to cash in, as we're being very generous leaving any of the banks as Hold recommendations when you can potentially earn more in a term deposit without the risk of losing money.
This article has been reproduced with permission from Intelligent Investor - Nathan Bell is the original author
