Bendigo and Adelaide Bank (ASX: BEN) is one among the regional Australian banks that does not belong to the big four. Bendigo is the fifth-largest bank in the country, leading along with the Bank of Queensland (ASX: BOQ) in the regional banking sector. Bendigo, similar to most banks, depends on revenues generated from interest income from the loans they are offering to individuals and/or businesses. On top of these revenues, Bendigo also earns fees and commissions.
What differentiates Bendigo from “another” institution is that it is structured as a “community bank”. Unlike the other banks, Bendigo is operating as a franchise for each of its bank branches across the country. It all started in the late 1990s, when the centralisation of the Australian banking industry took place, causing the contraction of the banking institutions and substantial economic decline across many of Australia’s small rural communities. That is where the idea of the Bendigo community bank model emerged.
The idea is simple. It is to develop the bank branches structured as a franchise with attributes of a cooperative to respond to a banking industry that is becoming distant to its customers. The model has supported the recirculation of capital into much needed regional economies. Today, Bendigo has 320 community bank branches operating not only in rural communities but as well in urban centres nationwide. Unlike the big four, Bendigo does not embark on a quest to cut costs at all costs at the detriment of the customer services by closing branches in favour of online and digital banking. Rather, the company is seeking to stay close to its customers via its community bank branches where the firm believes growth opportunities exist.
Source: Bendigo and Adelaide Bank
Since the past five years, Bendigo continuously grew its bank branches footprint across the country contributing to a steady increase in Loans and deposits. Hence, loans grew by a CAGR of 3.13% while deposits expanded by a CAGR of 6.37% since the second half of FY17. These attest to the good strategy to remain geographically present where demand exists. Along with the 320 community branches, Bendigo has a diversified portfolio of brands that are also physically present nationwide such as 144 company-owned branches, 14 Delphi Bank branches, 193 Rural Bank branches, 16 Alliance Bank Branches and 4 Private Franchises. It is also worth noting that Bendigo’s cash earnings are coming from the regional branches with predominantly cash income from consumers which represents almost 62% of the total cash earnings, followed by the bank’s business division and Agribusiness with 25% and 13%, respectively.
A different approach to grow
FY20 was a difficult period for all the businesses and particularly tough for the banking sector. COVID-19 has disrupted our lives. Uncertainty, negative economic conditions, and a low-interest-rate environment are few challenges that banks navigated during that period. On a positive note, the banking sector recovered faster than other industries and even outperformed the broad market. As of the first half of FY21, Bendigo returned to its earnings growth led by a strong cash inflow from its business division which went up by 39.7%. The Agribusiness division did particularly well with a 25.8% increase in its cash earnings followed by the largest division of the bank, which saw its consumer cash earning up by 12%. During the period, we also have seen Bendigo successfully reduce its operating costs across the business segments. The bank has shown quality execution and made progress swiftly on its strategy to grow and accelerate its transformation to become what the firm said, “Australia’s bank of choice”.
Bendigo’s strategy consisted of remaining close to its customers and particularly being physically present in regional and local communities while repositioning its finance to support growth in customer numbers and market share. The two key earnings growth drivers for Bendigo lies in the firm’s ability to expand its cash deposits and loans. The company expects that growth will come from a positive customer experience which the bank continuously delivers as demonstrated through its net promoter score of 29 that remains relatively higher than the industry average at 28.8. This contributed to a continuous increase in the bank’s number of customers from 1.79 million in the second half of FY20 to 1.96 million in the first half of FY21. This is a decent average growth of 9.5% per annum. Bendigo is also steadily gaining market share compared to major banks which are experiencing a constant decline since the first half of FY20. But one of the key metrics that impress us the most, is the total lending growth that Bendigo is capturing. Total lending growth reached 9.2% during the first half of FY21. All these figures are proving that Bendigo is outperforming its peers.
Source: Bendigo and Adelaide Bank
Positive agricultural Sector conditions supported Bendigo strong performance
Bendigo’s earnings growth has also been remarkably supported by its Agribusiness division buoyed by favourable agricultural conditions which brought a cash earnings contribution up 25.8% whilst operating expenses went down by 5.9% during the first half of FY21. During the period, Bendigo saw a higher-than-average loan balance, which combined with a good margin led to a higher net interest income.
FY21 onward outlook: Accelerating business transformation
While COVID-19 took centre stage during FY20, Bendigo took the opportunity to help its customers and the community by providing loan deferrals. The Bank also did play an important role in providing credit to help the economy. As of December 31, 2020, more than three thousand customer accounts remained on deferral, down 86% from the peak in May last year. The approximate value of accounts where repayments have been deferred is $1.1 billion, down 84% from the peak of last year of $6.9 billion. As of the beginning of this year, the total number of loans on deferral arrangements represents less than one per cent of the total Bank’s loan book. The loan deferral impacted the company’s earnings throughout FY20 and the first half of FY21 to some extent. As we see the deferral support campaign reaching its end, we expect a strong rebound in earnings growth in the following months.
Bendigo, like other major banks, is highly sensitive to the low-interest-rate environment which affects the company’s net income margin. Therefore, the bank has decided to transform its business and find areas for improvement. It started with the optimisation of the company’s branch network with a new community-focused experience store in Bendigo. The bank’s strategic imperatives consist also in the reduction of operational complexity by simplifying and modernising the firm’s technology and implementing digital capability to cut costs. As we said, “if it ain’t broke, don’t fix it”, The transformation programme is not intended to completely shift the business approach, but to improve a couple of things to drive sustainable growth and manage costs more efficiently. Looking ahead, we see Bendigo well supported by its development and transformation initiative. We continue to see residential lending growth along with small businesses and the agribusiness sector. During the last period, the company has demonstrated quality execution and has successfully reduced its cost base whilst maintaining a strong and resilient balance sheet. We are convinced that it is likely to continue onwards.
Low-interest rates are here to stay for a certain time. The RBA has decided to keep rates at 0.1% for at least the next three years. With this coming into the picture, the central bank now expects growth of 4.75% to take place over 2021. The main reason to keep the interest rates that low is to attain higher economic growth while reducing the unemployment rate. The low-interest rates are something that banks hate as it affects its stability through several channels. Banks can experience a decline in their profitability and a squeezed net interest margin. A fall in the interest rate tends to flatten the yield curve, which can be negative for net interest incomes, reflecting that the banking institutions tend to borrow short term and lend long term. However, the low-interest rate should increase borrowing, and this has been working well.
Despite the ongoing low-rate environment, we remain quite optimistic regarding the return of business confidence and positive consumer sentiment along with a growing housing market and an improving jobs market. We have seen growth in regional Australia back on track progressively.
The return to earnings growth
The first half of FY21 marks the return of Bendigo to earnings growth. Hence, the bank reported an impressive statutory net profit of $243.9 million, which is 67.3% better year on year. Profit has been boosted by well-managed cost control and an increase year-on-year by 1.9% in cash earnings after tax to $219.7 million. Furthermore, total income on a cash basis went up by 3.3% year-on-year reaching $849 million. Bendigo net interest margin decreased year-over-year to 2.3% losing 7 basis points due to unfavourable economic conditions caused by COVID-19. However, the net interest margin improved by a marginal basis point since the second half of FY20. We have also witnessed an improvement in bad and doubtful debts which went down by 15.9% to $19.5 million. The bank is also well-funded and reports a CET1 of 9.36%, up 36 basis points from last year. All in all, Bendigo exhibits a strong and resilient balance sheet supported by an increasing number of new customers which brought total lending to $88.3 billion, up 8.6% and total deposits of $72.3 billion, up 8.5%.
Source: Bendigo and Adelaide Bank. CET1 and total capital.
Bendigo’s Net Interest Margin above its peers
The ability to maintain a net interest margin demonstrates the capabilities of a bank to perform during a low-interest environment. In short, the net interest margin is the indicator of a bank’s profitability and growth. It shows how much a bank is earning in interest on its loans compared to how much it is paying out in interest on deposits. We have compared the interest margin of the big four plus the Bank of Queensland which we consider the direct competitor of Bendigo, and we have found that over the past four half-year results, Bendigo is outperforming its peers consistently by an average of 20 basis points. This alone proves that the bank has the capacity to grow further.
The Solid decrease in recurring operations contributes to a decline in expenses
During the first half of FY21, operating expenses were $517.4 million, down 3.1% on the half, driven by a strong focus on achieving sustainable cost reductions across the business. Technology and transformation investment spend to support the Bank’s strategic imperatives was $35.2 million. Underlying operating expenses declined by $17.6 million for the first half, reflecting Bendigo refocus on sustainable reductions in the cost base. Most of the Bank’s Full-time Equivalent (FTE) reductions occurred in November and December, which means that expected cost-benefit will be pushed to the second half of FY21. Bendigo’s accelerated focus on its cost reduction programme delivered a solid decrease in recurring operating expenses which added to a sustainable improvement of the company’s cost to income ratio that decreased by 520 basis points compared to the second half of FY20. At this rate, we can expect Bendigo to return to target income growth to exceed cost growth by the end of FY21.
Source: Bendigo and Adelaide Bank. Operating expenses.
Bendigo declared a dividend of 28 cents per share which includes 4.5 cents per share relating to the full year 2020 final dividend and 23.5 cents per share of the interim 2021 dividend. The company is also offering a dividend reinvestment plan which has been announced to be available with a 1.5% discount. Bendigo exhibits a strong capital position and is well-placed to capture the rebound given the positive business outlook. The bank is looking to maintain its dividend yield steady at 2.75%. If you are looking for a solid dividend from a bank, Bendigo may not be the one to choose from. The company provides a dividend yield of 2.74% which is below the median dividend yield of the “Big Four + BOQ” which is 3.45%.
Revenues Forecasts & Valuation
The narrative so far for the entire industry and Bendigo is the swift recovery of the economy after more than a year of turbulent circumstances. The headwind for Bendigo and the rest of the banking sector in Australia is the bleak growth profile. The country is facing a fading demographic expansion, although we can expect borders to be reopening soon which could enable once again – much needed population growth. With the market already captured for the current products and services, the room for growth is quite limited.
The only significant way for the banking sector to continue to produce growth with current operations is by gaining market shares from their peers through innovation or better customer services. Most of the banks are betting on the innovation field by developing their digital platform surfing on the Fintech wave. However, Bendigo is moving in a different direction, closer to its customers through the development of its branches. For the bank, the technology transformation should be done on the “Backoffice side”, and cost savings must be realised by improving its operational efficiency through new technology platforms and not at the detriment of customer services. Bendigo’s revenue is expected to grow onward FY21 in line with Australia’s GDP which is projected to be 4.75% by the end of 2021 and 3.5% from 2022 according to the RBA.
On the valuation front, Bendigo currently trades at around 21.7 times P/E – putting it on the cheaper end among the “big four + BOQ” stocks. In our view, Bendigo remains relatively cheap vis-à-vis its direct competitor in the regional banking sector with a P/E of 21.7 times versus BOQ’s P/E of 37.13 times. Also, in terms of efficiency, Bendigo is outperforming its peers with a Net Interest Margin at 2.3% versus a median “big 4 + BOQ” of 2.10%. Liquidity-wise, BEN is likewise doing relatively well with a liquidity coverage ratio of 154% well above the industry median of 138%.
Bendigo has performed well in the recent past and the firm has managed to increase their market share. The headwind for Bendigo is the bleak growth profile in the Australian banking space. Due to this headwind, we have seen all the big 4 banks striving to reduce operating costs in order to increase profitability. However, Bendigo’s is not looking to aggressively cut costs given their customer service centric strategy. Bendigo’s dividends are also less than the average banking sector, and we believe BEN shares are trading at fair value. Therefore, we recommend a “Hold”.