Don’t bank on it getting better
Invest for the long-term. That’s the catchcry of a phalanx of commentators since investing in equities emerged from the shadow of railway bonds. But investing for the long-term only makes sense if you invest in extraordinary businesses. The longer you stay invested in mediocre businesses the greater your loss in either nominal terms or opportunities foregone – or both.
A quick scan of the share price of Telstra, AMP or the NAB reveals today’s share price is lower than were it was more than a decade ago. Long term investing in these businesses has produced poor outcomes for investors who may still unwittingly describe these businesses as ‘blue-chip’.
In The National Australia Bank’s case, the share price of $31.73 at the time of writing, is lower than where it was in May 2001 – almost 15 years ago.
In the short run the market is a voting machine but in the long run, share prices cannot help but reflect the economic performance of the underlying business. The poor long term share price performance, suggests the economic performance of the business has been mediocre at best.
It has certainly been the case that the return on incremental equity for the NAB has been lower than its peers and we have hitherto put that performance down to the overpriced Clydesdale UK acquisition, which the company is now extracting itself from.
But the 2015 results just released, suggests we have been far too sanguine about the remaining Australian business. The 2015 full year results indicate a mediocre local business as well.
Here’s a few salient points:
- NAB reported cash earnings of A$6.718 billion up 2.4 per cent year-on-year, (ex specific items). This appears to have been around 1-5 per cent lower than consensus primarily due to a weaker Net Interest Margin in Australian business lending and in NZ
- Expense growth is a little higher than most expected and bad and doubtful debt charges are lower. This suggests the ‘quality’ of the earnings is lower
- The final dividend of 99cps is flat on the pcp and the interim dividend
- Cash Return On Equity fell 12-bpts year-on-year to 13.8 per cent before specific items
- CET1 (Common Equity Tier 1) ratio increased to 10.24 per cent. This will fall by 0.80 per cent with the increase in mortgage risk weights, a further 0.40-0.50 per cent following the demerger of Clydesdale, offset by a 0.50 per cent increase following the sale of 80 per cent of the Life Insurance business. This puts NAB at around 9.5 per cent underlying.
Our main concern was the 0.10 per cent fall in business lending Net Interest Margin in Australia in 2H15 versus 1H15. It suggests increased competition in this market, possibly as a result of the APRA curbs imposed on mortgage growth.
Underlying profit growth in Australia was just 1.2 per cent year-on-year in 2H15. NAB’s expense line has blown out a bit on increased systems and people investment, resulting in an increase in its Australian expense ratio by 1.5bpts on the pcp to 42.3 per cent in 2H15.
The other concern was the fall in new, bad and doubtful debt charges. While the overall net Behaviour Driven Development charge in Australia fell by 18.3 per cent year-on-year in 2H15 to support cash earnings growth, specific charges fell a massive 47 per cent to their lowest recorded levels. This primarily appears to be due to falling charges on mortgages (down from A$27 million in 2H14 to just A$6 million in 2H15) and Small and Medium enterprises (down from A$99 million in 2H14 to just A$37 million in 2H15). This is not a sustainable driver of earnings and will be a drag on earnings growth in future as it mean reverts. Mean reversion is even more likely when interest rates are at historic lows and the property market booming.
Even in the absence of the drag on returns from the UK business, this appears to be a mediocre bank.
There’s now arguably three tiers of banks in Australia; ANZ, CBA and WBC form Tier 1 banks, NAB is arguably Tier 2 and then we have the regionals at Tier 3.
The conclusion makes me seriously wonder how much influence large institutional shareholders have on Australian listed company boards. Do you remember the bold public relations and advertising campaign that saw NAB announce it was “divorcing” the other big four banks? That campaign was named the best public relations campaign in the world in Cannes in 2011.
So what happened to that ad? My understanding was that it was working well.
Did fund managers, with their allocations made, possibly ask the NAB to ‘cease and desist’ in order not to disrupt the status quo? Who knows. All I know is that NAB is not in the same league as the other banks in terms of economic performance, and this is despite a solid tailwind.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Dean Tipping
:
Hi Roger,
Good article.
No doubt NAB have had a shocker in terms of capital growth over the time frame mentioned and past management have to cop for that. What’s the Montgomery team’s thoughts on the current management?
Thank you.
Dean
Roger Montgomery
:
Only time will tell. As the column suggests, the score card is not as impressive as some of the others who have taken to the field.
Dean Tipping
:
Thanks for the reply Roger.
On another note, what do you think of the change in China to the “2 child’ policy. Whilst it will take at least 9 months to kick in, have they pulled a rabbit out of the hat?
Should be good for Bellamy’s.
Regards,
Dean
Roger Montgomery
:
It should be very good for Bellamys. The question is, has the price already reflected it? Profits would have to double, three times to get to a ‘normal’ P/E. Working backwards you have to ask whether the 6 year deal they signed with Tatura Milk Industries permits the volume required to meet the demand and those earnings expectations.
Dean Tipping
:
A P/E of 58.18 is out of my league…thanks again for the reply…it’s great to be able to have this type of interaction with the Montgomery team.
Gav
:
Hi Roger, how do you think ANZ fared by comparison? Would you rank it above WBC/CBA on quality?
Roger Montgomery
:
Hi Gav,
ANZ released its FY15 result yesterday. Quoting our senior analyst Stuart Jackson, the main points of note were:
· Overall the result was slightly below consensus. However, this was mainly due to losses in the Trading book in 4Q15. Given the volatility of earnings in this business, the market is likely to look through the weakness. Therefore the result was better than it looked.
· Expense growth improved, with the NZ business flat in local currency and Australian expense growth slowed to 4% in 2H15 on the pcp. The weaker revenue growth resulting from trading losses led to an increase in the expense ratio, but this is likely to be one off. In constant currency, expenses increased 3% in FY15. 2H15 expense growth excluding the impact of the lower AUD was ~1.7%.
· NIM stabilised in 2H15 relative to 1H15. This is an improvement on recent performances. Loan book growth maintained its momentum due to accelerating growth in mortgages. The International loan book declined, as the business moves away from low return trade finance.
· Broker commentary is indicating the flat NIM on 2H15 at 2.04% was better than expected. However, Stuart Jackson thinks this was more mix driven, with negative loan growth in low NIM Asia. Australia in isolation was down marginally on 1H15 and NZ was down 5bpts. The stable group average is more a function of strong loan growth in Australia. ANZ has gained share in cards, mortgages and SME in Australia and NZ.
· Interestingly, ANZ commented that while Australian corporate market was competitive, its NIM was only down 3bpts yoy. This compares to NAB’s 10bpts reduction. Hence NAB was weak today.
Gaveen Jayarajan
:
Hi Roger, thanks, I thought they did good in AUS and NZ given the conditions. Why was there such a savage reaction from brokers with downgrades from this? Are people reacting to their Asian strategy and do you think this will come back to bite them? Christopher Joye in today’s AFR declared that ANZ’s Asia strategy has failed. ANZ is my only bank holding.
Roger Montgomery
:
Hi Gaveen. Stay tuned. We’ll post something soon.
Mike
:
Generally I agree that NAB is lower quality but I take issue with one part of your article.
Comparing the share price between now and 10 or 15 years ago is misleading.
If Investors reinvested all their dividends since May 2001, NAB has returned close to 135%, while AMP has returned 49% over the past decade and Telstra 21%.
Okay, not great returns I admit, but still not a loss as your article implies.
NAB in particular has also issued a ridiculous amount of shares in that time, so all things being equal, we should expect the share price to be lower.
Mike
Roger Montgomery
:
Hi Mike, I wasn’t implying a loss. I was directly saying there have been much better, and identifiable, returns elsewhere.