MACQUARIE: Investors are overly pessimistic towards Australian banks

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Australian banking stocks have had a tough start to the year. The ASX 200 Banks index has fallen 8.4% since March 18, extending its fall from the beginning of the year to 13.7%.

Concerns over their exposure to the mining sector, along with the potential for a correction in some high density residential property markets, have taken their toll, wiping billions from banks’ share prices as a consequence.

While other investors are fretting about the potential for a spike in asset impairment charges, Jason Todd, Morana Hunter and Pelen Ji, Australian equity analysts at Macquarie, do not share this view. Indeed, the trio state that even with the substantial falls seen in recent weeks, they remain positive towards the sector.

“Impairment and capital concerns are real but we think overdone,” they wrote in a research note released on Tuesday. “We believe the sector is one of the few to offer pricing power.”

Here’s the basis for their call, something that has seen the bank retain its overweight rating towards the sector.

We are overweight Banks primarily on valuation and yield support grounds. The sector is now trading at ~12x forward earnings with solid dividend yield support (our analysis indicates that current pay-out ratios, of ~75% can be sustained in a low credit growth and benign credit quality environment). While fundamental issues around the sector’s growth outlook and credit quality cycle continue to impact investor sentiment, we think bank capital issues are dealt with for the foreseeable future and risks around impairment are becoming overly pessimistic.

The chart below, supplied by Macquarie, shows the average 12-month forward price-to-earnings (PE) ratio for the majors. After sitting above its long-run average for the best part of three years, at 12, it currently sits around its historic average.

Macquarie retain large overweight positions in CBA and WBC, and have recently added the NAB to its portfolio.

“Following a brief period of underperformance in 2015, NAB’s housing market share trends have stabilised and we have begun to see its investor trends moderate,” say Todd, Hunter and Ji.

“NAB is currently trading at ~10x FY16 PE multiple – a ~9% discount to peers. We see both relative and absolute value at current levels.”

Though Macquarie retain a positive view to the major banks, that optimism has not extended to diversified financials or insurers with the bank retaining underweight allocations to these sectors.

The table below reveals Macquarie’s current portfolio allocation by financial subsector.

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