COVID-19 has come with higher credit impairment charges that have also forced the banks to acquiesce to APRA’s wishes for either deferred or materially lower dividends.
However, underlying performance in 1H20 continues to be sound and balance sheets are much stronger than ever before – underpinned by targeted credit growth, better lending and funding quality, “unquestionably strong” capital levels and more than sufficient credit impairment provisions. In terms of the latter, the majors’ total impairment charges currently sit at ~$7bn. These are projected to increase to ~$29bn over the next three years (ANZ ~$8bn, CBA ~$8bn, NAB ~$6bn and WBC ~$7bn) and compares to the equivalent GFC figure of ~$27bn (ANZ ~$6bn, CBA ~$7bn, NAB ~$8bn and WBC ~$6bn). Consequently, it is also our view that some provision writebacks are inevitable once this pandemic is over – post-GFC data indicates write-back rates of at least 15-20% for the majors.
Price target and rating changes
Sector cost of equity has improved by 1.8-2.0% since March 2020 and our conservative revisions are listed below (no change to BEN as we had previously adjusted for this, and also no change to MQG given its market-sensitive and offshore activities). New price targets net of DCF rollover: (1) ANZ – previously 12.0%, now 11.0% and price target +3% to $19.50; (2) CBA – previously 11.0%, now 10.0% but price target broadly maintained at $72.00; (3) NAB – previously 12.0%, now 10.5% and price target +13% to $19.50; (4) WBC – previously 12.0%, now 11.0% and price target +6% to $18.30; and (5) BOQ – previously 13.5%, now 12.5% and price target +4% to $5.70. All cash earnings forecasts are unchanged. WBC’s Hold rating is reinstated purely based on value (i.e. total expected return now <15% and with the share price up by >16% since our Buy upgrade); all other ratings are unchanged.
Sticking with MQG and CBA
It is only prudent to stick with quality stocks that are both resilient and capable of seeking out opportunities in times of crisis. So it comes as no surprise that MQG remains our top-rated stock. Its business model is built upon annuity-style and markets-facing activities and continues to work well, being capital efficient and flexible enough to deploy capital across higher return activities and fund dividends from nonbank activities. MQG remains the classic “Cash and Growth” story in our view.
Of the majors, we don’t think investors can go past CBA given its earnings quality and consistency. The balance sheet is also in good order with sufficient capital, funding and now provisions, and sound asset quality. Once completed, recent-announced divestments should lift CET1 to 11.4-11.5% and place the bank ahead of its domestic peers and near the top end of the global “unquestionably strong” club. As well, underlying organic capital generation in 3Q20 was strong at +12bp and there is scope for CBA to comfortably declare a 100¢ final dividend.