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Date : 28/06/2021

ANZ Banking Group

ASX :

ANZ

Market Cap : $80.35 Billion

Dividend Per Share : $0.7

Dividend Yield : 3.71 %

Hold

52 Week Range : $16.40 - $29.64

Share Price : $28.28

ANZ faces a limited growth outlook. Given the current high prices and the return of dividends, we recommend a "Hold".

Company Analysis

Part of the “Big 4”, ANZ is also the largest banking group in the Pacific region. While the likes of CommBank, NAB, Westpac operate primarily in the Australia and New Zealand regions only, ANZ has a presence in 33 markets globally with representation in Asia-Pacific, Europe, America, and the Middle East. ANZ is also a big player in the international scene and is among the top fifty banks in the world.

ANZ shares have had a strong rebound since March 2020 lows and have continued to progress quite well year-to-date. We think so far that the rally continues to be reasonable given the positive economic momentum of the recovery in Australia. The firm did perform along the lines of its peers, benefiting from better-than-expected results and made a considerable net provisions release during the first half of 2021. In the ongoing low interest rate environment, ANZ was under pressure on the top-line metrics as the bank charged its clients fewer fees, however, the underlying core result was strong due to the significant increase in volumes of mortgages and business loans – leading to a better outlook.

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Source: Tradingview.com

As of the first half of FY21, the bank reported an impressive 90% year-over-year increase in its statutory profit to $2.94 billion driven by a net provision release of $491 million. One of the most tracked key metrics in the banking sector is the cash profit from continuing operations. ANZ did double its value to $2.99 billion. That is a considerable increase considering it is 28% more than what was reported during the second half of FY20.

The bank did take a lot of precautionary action during CY20 to cover potential losses against eventual shocks from the COVID-19. Other banks did take the same approach as ANZ; however, the pandemic has been less financially disruptive than anticipated and vis-a-vis the massive provisions built upon their books. A key contributor to the bank’s profits during the period was the $491 million cutbacks in the provision for bad loans. That is a stark contrast compared to last year when the provision surged by $1.7 billion.

ANZ’s total reserve for bad loans stays at $4.3 billion as a buffer in case the economic environment deteriorates once again. All in all, ANZ exhibits a solid balance sheet. We like the fact that the bank has a comfortable level of liquidity with the CET1 ratio up to 12.4% as of the second half of FY20 compared to 11.3% in the first half of FY20. Furthermore, tangible assets remain nearly unchanged from the first half of FY20, the credit risk-weighted assets and the exposure at default is declining from 36% to 30% since the first half of FY20.

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Source: ANZ

The economic rebound is looming, yet uncertainties are still there

One of the key elements contributing to the bank’s profitability is the fees charged to its customers. Given the low-interest-rate environment, ANZ as all other banks were affected by the lower fees margin compared to the second half of FY20. The interest rate is one of the external factors that banks cannot control much. However, ANZ did relatively well compared to its competitors. The bank noted that process and system improvements have seen it move into third place in the Australian home lending market. ANZ added about 92 thousand new home loan accounts in the Australia Retail & Commercial division over the past six months.

With 42% of all retail sales, including home loans now via digital channels, ANZ is looking to further increase that percentage going forward as the company strives to cut back on its costs through its digital transformation. The Australia retail and commercial division was the key contributor to the increase in the group cash profits over the past six months bringing $659 million of the total cash profits of $2.99 billion.

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Source: ANZ

Strong improvement in cash position: Dividends back on track

As Australia is looking to rebuild and strengthen its economy after a year of turmoil, banks have a major role to play. We have seen priorities fixed among the “big four” to invest and accelerate their digital processes to ensure the economy makes the transition into a digital one. And it has been no exception for ANZ. The competitive viability of the bank lies in its effectiveness in a cutback on its operating costs to stay relevant, particularly in a low-interest environment where margins are shrinking. We have seen throughout the period that ANZ continues to progress with its plan to simplify and streamline its business. The company reported a 1% fall in expenses over the past six months and a 2% decrease year-over-year. ANZ plans to stay on track to further lower the cost base by an additional $900 million over the next few years by continuously modernising and developing faster transactions processing with digitalisation. The first half of FY21 has also been strong in terms of cash generation and we saw ANZ making strong improvements in that department with a substantial net provisions release.

The worst appears to be well behind us given the strong momentum in both the Australian and New Zealand’s economic upturn. ANZ’s credit quality was terrific leading into the crisis, and the levels of bad loans remain lower than earlier expected. The combination of a better outlook along with capital generation on top of a solid balance sheet led the bank to reconsider a return of its dividend to a pre-COVID payout ratio. In fact, the dividend has already bounced back faster than the market has expected. ANZ increased its interim dividend to a fully franked 70 cents per share, exceeding the anticipated 63 cents.

Company Updates

FY21 onward Outlook: Transform into a modern and cost-effective banking institution

ANZ started to work on streamlining its operations well before COVID-19 hit us. The bank navigated through the pandemic with a simplified business model after withdrawing from many of its markets in Asia. We believe that ANZ is well-positioned to find the right equilibrium between a leaner operation and growth. The company exhibits a rock-solid balance sheet that supports its investment priorities to a leaner and more efficient institution. By FY23, ANZ intends to significantly increase its capital allocation to develop its digital ecosystems and into emerging technology through its venture capital arm ANZi.

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Source: ANZ

Australia, retail, and commercial division: Reduction of costs at all costs

The Australia retail and commercial division is ANZ’s largest cash profit contributor. In line with the group strategic plan, the retail and commercial division goal for FY21 onward is to simplify and make sure to develop an efficient business more in phase with today’s clients’ expectations. We saw the retail and commercial division grow sustainably over the past few years, but the recent health crisis has changed the way the bank is approaching and developing its entity. ANZ is reshaping its business for a post-COVID world which the company believes should be more digitally oriented and highly automated. ANZ has indicated its intention to invest consequently in the business through the economic cycle while continuing to reduce costs to a more sustainable level. The bank made significant progress throughout FY20 to simplify its operations, introducing a more targeted approach in the financial advice division to focus on affluent and high net worth clients. Furthermore, ANZ plans to reduce its ATM fleet and announced the sale of 1,300 offsite ATM machines to Armaguard. The reduction of the bank’s “physical footprint” is synonymous with fewer costs. Hence, across ANZ’s branch network, we saw the bank investing heavily to open “digital branches” to provide customers with new self-service options, including smart ATMs and business cash deposit machines.

Institutional division: Revenue hit by the low-interest-rate environment likely to continue

The institutional division has been quite affected by the pandemic during FY20, still, 1% cash profit growth has been delivered compared to FY19 despite the unfavourable economic conditions. Net loans and advances declined by 4% after peaking in the middle of the year, while client deposits went up by 3%.

We all know that a low-interest-rate environment is detrimental for the banking sector as the bank will encounter more challenges to remain afloat with depleted margins. Throughout 2020, transaction, banking and corporate finance revenue went down 15% and 1% respectively. On a positive note, the market’s revenue increased by 49%, as customers sought to manage their financial risks amid heightened volatility in the global markets. Going forward FY21, the institutional division will continue its effort on improving productivity and contribute to further cost reduction. Unfortunately, it will involve staff reduction.

Low-interest rate is likely to remain for an extended time and we expect a rate hike earliest by the end of FY22. We expect a relatively positive economic outlook, however, we are also concerned about the credit charges increased with tougher economic conditions. Still, ANZ’s credit quality of the book remains fairly strong.

New Zealand division

Despite difficult conditions, the New Zealand division maintained a leading position in core banking products with about 31% share of mortgages, 33% share of households’ deposits and about 22% share of KiwiSaver. Net loan and advances were solid for FY20, underlying net loans and advances grew by 3%, driven by home lending growth of 6%. This was supported by a relatively resilient housing market. Furthermore, we saw customer deposits grow by 9% facilitated by inflows from the government’s wage subsidy scheme and an increase in liquidity bolstered by quantitative easing measures from the RBNZ. The low-interest environment impacted the banking sector as well in New Zealand, hence affecting the revenue and putting some stress on the interest margin.

Going forward FY21, we continued to see New Zealand’s division refining its physical presence to fewer, improving its branches, enabling an efficient and simplified operating model. Also, during the period, the bank completed the sale of UDC Finance Limited to Shinsei Bank in line with the group simplification strategic plan.

Macroeconomic Outlook

2020 was the year of extremes. We have witnessed the largest synchronised quantitative easing in history. Central banks around the world took unprecedented measures. We saw a substantial increase in money supply across several economies which helped to offset the disastrous impacts which were anticipated throughout much of the crisis. Going forward 2021, the path to immunisation becomes more evident and the withdrawal of governments stimulus will become a critical issue for economies. The ramp-up of the global vaccination campaign provides hope for a quick rebound to sectors that have been the most affected by the pandemic. We think about travel, tourism, and the discretionary sector. According to many analysts, the return to normality is expected for later this year or early 2022. While we remain optimistic, it is worth noting that not all sectors and regions are equal toward the return to pre-COVID levels.

Our focus is on stimulus withdrawal and monetary policy. The Federal Reserve (Fed) and the Reserve Bank of Australia (RBA) have expressed their decision to take the necessary time before attempting any interest rate hike. As a result, we do not see the Fed or the RBA raising interest rates until at least the end of 2022.

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Source: ANZ. Global GDP Growth.

We have witnessed a good rebound in the Australian economy out of the pandemic, essentially supported by the significant monetary and fiscal stimulus. As a result, we expect GDP to grow by 4.4% by the end of 2021. Despite our optimism on the return to pre-pandemic levels, we are still concerned about the removal of both fiscal and monetary stimulus measures, which we believe will be a key challenge for policymakers over the next few years. We think that an earlier-than-anticipated withdrawal of stimulus is a key risk. While these headwinds will emerge in 2022, a combination of restricted spending through the lockdowns and income support has driven household saving rates to record levels, providing a significant cushion as stimulus measures are withdrawn.

Revenues Forecasts & Valuation

The narrative so far has been that of a stunning recovery in considerably turbulent circumstances. The headwind for ANZ and the rest of the big 4 in Australia is the bleak growth profile. Our demographics are limited, and yes, immigration will cause a minor uptick once borders are open, but there is no significant uptick in population on the horizon. With the market already captured for the current products and services, the room for growth is very limited.

The only significant way for the banks to generate growth with current operations is by capturing market share from their peers and by innovating with new products. The former is easier said than done given the dominance of CommBank over the rest of the Big 4. The latter is why we see more banks entering or trying to enter BNPL and other fintech markets. However, given the scale of their current business that generates on an average 17 billion in revenues, early revenues of a few hundred million from FinTech hardly makes a difference when the revenues flow from the top-line and translate into net income. Long story short, we estimate ANZ to grow along with the broader economy with growth rates similar to the GDP growth of Australia.

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Therefore, with revenue growth limited, ANZ and the rest of the big 4 are now concentrating on reducing their costs to drive profitability. This cost reduction will take the Net Income Margins back up to the high 34% and eventually go over 35% once the strategies have been completely implanted – resulting in an uptick in dividends.

On the valuation front, ANZ currently trades at around 17.5x P/E – putting it on the cheaper end among the Big 4 bank stocks. The less than 20x multiple is due to the limited growth prospects. Our models suggest this is a fair valuation of ANZ, especially given the dividends that are at play. Efficiency-wise, ANZ is the worst among the Big 4, and ANZ has the most work that can be done when managing costs.

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Recommendation

ANZ bank exhibits solid fundamentals, a rock-solid balance sheet with a comfortable level of liquidity. ANZ did pretty well during the pandemic and has performed optimally even in a low-rate environment thanks to its initiative to embark in a cost cutting programme. However, there is nothing exceptional here, ANZ’s performance is consistent with the “big four”. One thing that we like is the return to a pre-COVID dividend payout ratio. Due to the economic environment, we think that ANZ will deliver good performance as proved by its management discipline during the pandemic crisis, however, profit margins will likely remain tight for some time. We thus issue a “Hold” recommendation for ANZ.

 

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