Which Bank – NAB or ANZ?

Co-founder of the Switzer Report
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My 10 December article said “buy NAB, sell CBA”. I argued that Commonwealth Bank was 38% more expensive than the National Australia Bank, and despite it deserving a premium rating, the ‘mean reversion’ theory said that this was too much. A return to a more “normal” level of 20% was on the cards. What has happened since then?

As can be seen in the above table, the return over the last six months from investing in NAB has been almost double that of investing in CBA. In terms of “expensiveness” (based on forecast PEs), CBA is now around 23% more expensive than the NAB.

And the point of this story? The recent market pullback has made banking stocks attractive again (given the yield gap to the cash rate and relative predictability of earnings), leading to these questions from subscribers and others. CBA or NAB, or perhaps more importantly, what is your number one banking stock?

The ‘mean reversion’ theory

Australian banking is an oligopoly, and unless one bank kicks an “own goal” (like NAB did more than a decade ago when it purchased Homeside in the USA and then made a foray into UK banking), the ‘mean reversion’ theory tends to hold sway. The theory goes that in a mature, highly regulated market, it is very difficult for one of the participants to make major competitive gains over the other participants. Changes in market share are hard won and at the margin, cost bases are largely the same, they make use of similar technology, they tap the same talent pool, they share similar lending exposures etc. As a result, their profitability and return on capital will largely be the same.

As markets aren’t efficient, one bank is going to be cheaper than the others. The theory goes that over time, they will largely revert to the mean – the cheapest stock today will become (on a relative basis) more expensive, and the most expensive stock will become cheaper.

The theory aside, Commonwealth Bank has maintained its premium rating over the last decades due to its sound leadership, investment in technology and arguably, a stronger domestic franchise. It has consistently delivered the highest performance (in terms of Return on Equity) and accordingly, the market has consistently priced it as the most expensive banking stock in terms of forward price earnings multiple. The question is – just how much of a premium is warranted?

The Banks

Before dealing with the numbers, let’s take a quick look at the strategic issues. The table below sets out our view on the major “pros” and “cons” of each of the major banks.

The numbers and the market’s view

The table below lists the market consensus forecast estimates for the 2013 and 2014 fiscal years (based on Friday’s closing price). According to FN Arena’s sentiment indicator (where a measure of +1.0 is the most positive, and -1.0 is the most negative), the broker analysts are most bullish on ANZ (with a collective rating of 0.9), and least disposed to CBA with a reading of -0.3). Also, ANZ is furthest away from its consensus target price being 13.1% below.

The bottom line – our view

It is hard to argue with the broker analysts. Our sense is that while CBA still deserves a premium rating, the 23% premium to the NAB is too much and there is an increasing risk of ‘mean reversion’ as the other banks start to catch up and/or complacency at being on top for so long starts to take a toll.

As to our preferred pick, we narrowly favour the NAB over the ANZ. The additional dividend yield, lower PE, more focused investment in Australia and the fact that ANZ’s Asian strategy is really still only in its infancy swings us to the National.

Bottom line – while we really don’t see that much difference between the majors at the moment, our current investment ranking is:

  1. National
  2. ANZ
  3. Westpac
  4. Commonwealth

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.

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