ANZ reforms in search of sustainable profits
Key statistics: ASX: ANZ
Closing share price 15.11.16: $27.76
52-week high: $28.59
52-week low: $21.86
Most recent dividend: 80c
Annual dividend yield: 5.75%
Franking: 100%
No pain, no gain
What's new?
Unlike CBA and Westpac, which are already operating at close to optimum levels, NAB and ANZ have been weighed down by problematic exposures to regions and markets that have been generating a sub-par return (and in some instances actual losses).
However, it has been their ability to address these shortcomings during a period when top-line growth is limited that is now resonating with investors.
A case in point is ANZ's latest full-year results, which featured a headline statutory profit of $5.7 billion, representing a 24% decline on the previous corresponding period.
While this is obviously not an ideal outcome for shareholders, after stripping back the layers we view ANZ's 2016 financial results as a necessary stepping stone to improved and more sustainable earnings down the track.
From our perspective, the broad drivers of the results comprised a good performance from the domestic businesses and the significant reshaping of the institutional business, with a particular focus on low-yielding assets and improved productivity in Asia.
This, of course, is not dissimilar to what NAB is seeking to achieve by selling low-returning assets to create a simpler, better capitalised and more balanced bank.
Adjusting for the $1.1 billion of specified items that were reported in 2016, we note that ANZs underling performance through the period was not nearly as bad as the headline numbers suggest. While it still reported a 2.5% decline in pro-forma 2016 profit, this represents a marked improvement on the 18% decline in cash profit and 24% decline in statutory profit.
The other key point to note about ANZ's results is that while the cash profit was lower during the period, the impact that this had on net capital generation was negligible.
This was due largely to credit risk-weighted asset reductions (excluding foreign exchange impacts) of $12 billion in the bank's institutional business. This, of course, adds support to ANZ's CET1 ratio and ability to distribute 60%-65% of cash earnings as dividends.
Outlook
While it seems reasonable to expect management's transformation plans to crimp near-term earnings, we expect the strategy to ultimately pay dividends for shareholders.
Not unlike NAB, we expect ANZ's decision to optimise its operating structure and credit exposures to deliver incremental gains in return on equity over the next several years, with this likely to translate to higher per share metrics (book value and earnings multiple).
Price
Based on consensus earnings estimates for 2017, ANZ is trading on 11.7 times and offering a dividend yield of 5.9%. While noting the near-term earnings risks, we view the implied payout ratio as comfortable.
Furthermore, we note that ANZ's overall investment case is supported by the stock's technical set-up, with our analysis suggesting the recent share price gains will continue to press on toward a confluence of resistance at $29.80.
Summary
We believe that the near-term risks associated with ANZ's exposure to the Asian region have been factored into the share price.
Furthermore, on a medium-term view, we believe that ANZ's future growth prospects are arguably superior to those of its major peers, based on the view that the bank has a strong competitive position in Australia and New Zealand and an early mover advantage and more recently optimised exposure to Asia.
Disclosure: ANZ is held in the Fat Prophets Concentrated Australian Share and Australian Share Income models.
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