There is no doubting that the Big Four banks are hugely popular among Australian investors.
As at last year’s annual reports, Commonwealth Bank (CBA) had 795,000 shareholders; Westpac (WBC) had 572,000; National Australia Bank (NAB) had 476,000 and ANZ had 443,000. The banks are core holdings for many retail share portfolios.
There is a very good reason for this: the banks have been strong generators of both capital growth and dividend yield. For self-managed super fund (SMSF) investors, the bank stocks are major generators of dividend flow.
NAB’s full-year (FY) 2012 profit result yesterday showed why it is the weakest of the Big Four. NAB reported cash earnings of $5.4 billion, which was down 0.5% on the FY11 result. Net profit fell by 21% to $4.1 billion.
The cash earnings is what bank analysts mostly look at because it is used as the basis for calculating earnings per share (EPS), return on equity (ROE) and dividends. But here the investor has to keep an eye on the ‘one-off’ items that are being excluded – the banks have a bad habit of filling this category to the gunwales, with NAB the worst offender, ANZ and CBA middling, and Westpac relatively lilywhite.
NAB
NAB’s big problem is about $9 billion of troubled property loans held in its UK banking operation, which it took onto its own balance sheet earlier this year. Because of that, the bank had to swallow an increase of almost $800 million in its provision for bad and doubtful debts (B&DDs) to $2.6 billion, which marred a solid performance from its Australian banking businesses.
The UK losses will hurt NAB’s net profit for a few years yet. That is the cost of repatriating most of its British commercial real estate loans to the parent balance sheet, which enjoys lower funding costs.
NAB’s net interest margin – that is, the difference between interest income received and interest paid out – fell from 2.25% in FY11 to 2.11%. The bank managed to lower its costs by almost 2% on FY11.
ANZ
Now let’s look at ANZ, where there was a lot to like about the FY12 result. ANZ boosted full-year cash profit by 6% to a record $6.01 billion, while reported net profit rose by a similar percentage, to $5.66 billion.
ANZ (as well as Westpac and CBA) has nothing like the lead in the saddlebags that NAB’s UK headache gives the latter. ANZ was actually able to release $230 billion of provisions against B&DDs, and its bad debts charge only increased by less than 3%, to $1.21 billion.
ANZ did show signs of funding stress, with full-year net interest margins contracting by 11 basis points (0.11%). But on the plus side, revenue growth at 5% outpaced cost growth at 4%.
Dividends
But what most concerns SMSF investors is the dividend, and this was a good story. NAB lifted its full-year payout to 180 cents a share, up from 172 cents in FY11. ANZ lifted its full-year payment by five cents, to 145 cents a share from 140 cents.
The major banks are demonstrating that they can deliver solid dividend growth despite only modest profit growth. This should continue, because they have strong and improving capital situations (in which they are the envy of their global peers), and they are certainly not stretched on their payout ratios: CBA paid out 74.3% of its profit in FY12, ANZ 66.8% and NAB 68.8%.
Westpac
Westpac reports its full-year FY12 results on Monday, November 5. The bank is expected to lift its cash profit by about 5%, driven mainly by retail banking. But the dividend situation will be most interesting because Westpac has the highest payout ratio of the Big Four at 82%. If return on equity comes under pressure, Westpac could struggle to maintain that level of payout – although the market consensus does expect the bank to lift its dividend next week, from 156 cents a share in FY11 to somewhere around 165.6 cents.
But let’s cut to the chase for SMSF investors – the yields.
Comparing yields
Market consensus forecast expects ANZ to pay a dividend of 149.9 cents a share in FY13, rising to 157.6 cents a share in FY14. At a share price of $25.50, that places ANZ on a nominal yield of 5.88% for FY13, and 6.18% in FY14.
Market consensus forecast expects NAB to pay a dividend of 183.8 cents a share in FY13, rising to 189.5 cents a share in FY14. At a share price of $25.43, that places NAB on a nominal yield of 7.23% in FY13 and 7.45%.
As always, these yields have to be converted to the after-tax equivalent yields they represent for SMSFs making use of franking credit refunds.
An SMSF holding ANZ in accumulation phase is looking at an effective yield of 7.15% in FY13 and 7.52% in FY14. If the ANZ shares are held in pension mode, the effective yield to the fund is 8.35% in FY13 and 8.78% in FY14.
Similarly, an SMSF holding NAB in accumulation phase is looking at an effective yield of 8.80% in FY13 and 9.07% in FY14. If the NAB shares are held in pension mode, the effective yield to the fund is 10.26% in FY13 and 10.58% in FY14.
With term deposit rates at 4.8-5% and ten-year government bonds at 5.5%, these are simply outstanding yields for the level of safety implied.
The real yield
And it gets better. As I always stress, an SMSF has to assess the yield it receives on an asset based on what it paid for that investment. The after-tax yield received on an asset is ‘the yield that you eat.’
The Big Four banks’ track record of growing their dividend stream – let alone the accompanying capital growth they have generated – makes them truly magnificent assets to hold over the long term.
It is entirely possible that a lot of SMSFs hold bank shares that they bought for single-digit share prices in the 1990s. Because the dividends have increased over that time, the effective yields some SMSFs are receiving on the share dividend flow being paid to them in pension form are almost unbelievable.
Just as an example, it was possible to have bought Westpac for as low as $3 in 1992, after the bank had suffered badly in the 1990-91 recession. Admittedly that would have been considered a brave buy at the time, but 20 years down the track, not only do you have a share worth $25.40, but more importantly, you have a share expected to pay a dividend of about 165 cents a share when it reports on Monday.
Let that sink in – our 20-year Westpac holder is looking at a nominal yield of 55%.
If the shares are held in an SMSF in accumulation mode, you can bump the effective after-tax yield up to 67%. And if the SMSF is paying a pension, those original Westpac shares are generating a yield of 78%.
Of course, inflation has to be factored into that equation, but the point is that time and the ability of well-run companies to increase their profit and dividend payout consistently can throw off yields that seem incredible. The old saying that “if a yield looks too good to be true, it probably is” holds true in virtually all circumstances, except this one scenario of long-term dividend growth in the cream of Australia’s industrial companies.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Also in the Switzer Super Report
- Peter Switzer: Who’s afraid of the fiscal cliff [1]
- JP Goldman: Deep value in Shanghai stocks as index slides [2]
- Michael Heffernan: When to cut your stock losses and sell [3]
- Andrew Bloore: How the new SMSF audit rules affect you [4]
- Question of the week: SMSF bank accounts and interest rates [5]