Valuations for Australian bank stocks 'will get worse before they get better'

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  • Negative political sentiment and earnings headwinds will weigh on Aussie bank shares in the near term, Credit Suisse says.
  • But banks are starting to look cheap relative to the broader ASX200.
  • If prices continue to fall the banks may represent good value, as their business model remains fundamentally sound.

Australian bank stocks could be in for a rough six months before opportunities present themselves towards the end of the year, according to Credit Suisse.

For now, analysts Jarrod Martin and Brendon Ferreira said the headwinds facing Australia’s embattled banking sector — starting with negative political sentiment — are likely to drag on share prices in the near term.

In addition to the banking Royal Commission announced by the Turnbull government in November, research from UBS shows the sector is also facing a laundry list of other regulatory inquiries.

“We expect the news flow for the sector to get worse over the next six months and as such, expect valuations to remain weak as the market speculates further negative outcomes for the sector,” they say.

Along with the political backdrop, Martin and Ferreira also highlighted negative fundamental themes.

They said revenue growth is weaker amid increased competition for mortgage repricing, while lending growth is also below the long-term average.

Add it all up, and the price-to-earnings (PE) valuation multiples of Aussie banks have diverged sharply from the broader ASX200 in recent years.

But that’s where opportunity may lie if the negative news flow continues to weigh on bank stocks in the first half of this year, Credit Suisse said.

Martin and Ferreira based their view on the valuation of Australian banks compared to the ASX200 Industrials sector:

“Banks’ price-to-earnings multiples relative to non-bank industrials are at a relative low at 68%, versus the ten-year average of 82%,” the pair said.

And if those relative PE multiples fall to around 60%, it will present a good opportunity for investors to get back into bank stocks at a more compelling valuation.

Because for all the bad news weighing on the sector, the underlying business model of Australian banks is still solid.

“In recent years, the industry has faced increased scrutiny from the government and the media, with the reality being more benign,” Martin and Ferreira said.

“We see the 2018 financial year as somewhat of a lost year, with accelerated cost programs and political scrutiny overshadowing the operational execution underlying the bank sector.”

They said that while the focus on cost and efficiency initiatives is good strategic policy, banks won’t see the benefit in the near-term.

However, “these businesses are fundamentally not broken and have substantially de-risked over the years”.

In assessing the more positive themes for bank stocks, Martin and Ferreira highlighted the recent clarity provided by APRA on “unquestionably strong” capital ratios — a level which all the major banks comfortably met.

Australian banks now “hold more capital, are more focused on capital optimisation and are undertaking substantive efficiency programmes” — all of which should help to support earnings over the medium-term.

The CS analysts favour NAB among the big four banks, with neutral positions in CBA, Westpac and ANZ.

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