When it comes to the regional banks, my approach has been to consider investing only if they’re outstandingly cheap compared to the major banks. Being cheap relative to the market isn’t sufficient by itself.
Decades after Paul Keating tried to shake up the banking industry by inviting 15 well-capitalised foreign banks to open their doors in Australia, the four major banks still control more than 80% of the Australian banking market. The oligopoly is essentially untouched, with as much market power today as it had back in 1985. Further, market leadership and arguably much of the product innovation comes from the “Big 4”, not the other 140 regional, community and fintech banks.
As a firm believer in investing in “leaders” rather than “tier 2” or “tier 3” players, the regional banks (BOQ, Bendigo & Adelaide and Suncorp Bank), which are definitely “tier 2”, only grab my attention when they are “super cheap”. If I want to invest in banks, I stick with the majors.
So, with the BOQ share price tumbling towards Covid lows, it is time to take a look to see if there is any compelling value.
BOQ – 4/18 to 4/23
BOQ’s half year result
Last Thursday, new CEO and former Chairman, Patrick Allaway, released BOQ’s first half result to 28 February. Due to a goodwill impairment and provision for an integrated risk management program, BOQ achieved a NPAT of just $4 million. The underlying profit after tax was $256 million, higher than the second half of FY22 of $240 million, but down 4% on the 1H22 result of $268 million. The dividend was cut from 22 cents to 20 cents per share.
Excluding bad debt expenses, the operating profit before tax rose by around 9% on a sequential and corresponding period basis, from $370 million in 1H22 to $375 million in 2H22 to $407 million in 1H23.
But this covered a period when due to higher interest rates, the net interest margin rose by 5 basis points from 1.74% in 1H22 to 1.79% in 1H23.
Disappointingly, lending growth stalled with only a net $200 million in housing loans added to the balance sheet in the period (effectively, one tenth of the implied rate needed to perform with the rest of the banking system). Business lending did a bit better, adding a net $500 million in new loans.
Operating expenses rose by 4% compared to the previous half (2H22) and were up by 7% compared to 1H22.
Looking ahead, the net interest margin peaked in October 22 and BOQ anticipates “interim margin compression”. This is due to deposit competition as banks compete to refinance the RBA’s term funding facility, heightened mortgage competition and the need for increased liquidity.
Bad debts are expected to continue to normalise (still low by historic standards), while on the expense side, further growth is likely due to inflation, BOQ investing in operational resilience through an integrated risk program, and transformation activity.
But it is talk of a “transformation program with a focus on building a stronger, simpler and digitally enabled lower cost bank”, plus the $60 million provision to focus on risk and address operational resilience issues (including potential Anti-Money Laundering issues), that makes BOQ look like a re-write of Westpac. Clearly, BOQ has massively underinvested in technology over the last decade or two and is paying the price. It is a laggard on process automation, digitisation and operational resilience.
Strategically, it’s somewhat unclear how the BOQ customer offer (which includes ME Bank and Virgin Money) is differentiated from the major banks. The BOQ proprietary brand used to differentiate by providing “great service” using its owner/manager branch model, but if the banker is still using paper and manual systems, it is hard to deliver great service. The purchase of ME Bank looks like a messed-up acquisition, while Virgin Money has yet to set the world on fire. Business banking may be the ray of hope.
In summary, a couple of tough years ahead for BOQ as it plays “catch up” to the major banks. A bit like Westpac.
What do the brokers say
Apart from Ord Minnett, who is the outlier, the major brokers are somewhat negative on BOQ. According to FN Arena, there are 3 sell recommendations, two neutral recommendations and 1 buy recommendation (Ord Minnett).
Following the result, most brokers lowered their target price. It now sits at $6.54, some 8.3% higher than Friday’s closing ASX price of $6.04. If Ord Minnett’s target price of $8.50 is excluded, the consensus target price drops to $6.15.
FN Arena’s precis of UBS’s commentary on the result was as follows:
“Following a weak interim result from Bank of Queensland, UBS remains cautious on the stock despite the fact the shares are seen trading at what looks like trough valuation multiples.
Rising competition for local mortgages in combination with higher funding costs are considered a lethal headwind for the regional lender’s Net Interest Margin (NIM) outlook.
Estimates have been further lowered, predominantly on the anticipation of higher costs from operations.”
Net interest margin headwinds, rising costs and higher credit impairment charges were common themes amongst the brokers as they looked out to FY24 and beyond. Benefits from the transformation program and ongoing productivity initiatives will assist, but won’t fully emerge until FY26.
On multiples, the brokers have BOQ trading on a multiple of 10.5 times forecast FY23 earnings and 10.4 times forecast FY24 earnings. A total dividend of 44 cents is expected to be paid for FY23, implying a prospective dividend yield of 7.2%.
Bottom line
My sense is that BOQ is not going to fall out of bed. It is well capitalised, well funded, its asset quality is strong and more diversified (by type of exposure and geography) than it has ever been before. So, I don’t see it as a “value” or “yield” trap. Income investors will be attracted by the prospect of a circa 7% fully franked yield, so around $6, there should be some support.
That doesn’t mean that it is going to take off in the other direction (higher) because the growth prospects are poor. Buyers can afford to be patient. On a multiple of around 10 times forecast earnings (CBA is trading around 16.5 times forecast earnings), BOQ is starting to look attractive.
Portfolio holders will need to consider whether they have the patience to see it out and let the transformation program work. If you want “outperformance” in the next 12 to 18 months, BOQ is unlikely to be the stock.
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