ANZ Banking Group: The partial franking Halloween spook

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
01 November 2019, 3:45 PM
Sectors Covered:
Banks

  • ANZ has reported FY19 cash earnings from continuing operations of $6,470m, 1% better than we expected. Costs, asset quality and capital were the pleasing elements of the result for us.
  • A final dividend of 80cps has been declared with the surprise here being that it will only be partially franked at 70%. We expect ANZ’s franking to stay at this level for some time. We expect the other major banks to maintain 100% franking.
  • It appears that the market is forming negative margin read-throughs for the other major banks based on ANZ’s result; we believe this is largely unjustified. (Morgans clients can login to view detailed reports and price targets)

Negative margin read-throughs for sector largely unjustified 

ANZ’s margin performance was disappointing with the group NIM contracting from 180bps in 1H19 to 172bps in 2H19 (on a continuing operations cash basis).

 Based on the major banks’ share price declines today, it appears to us that investors are adopting negative NIM read-throughs for the other major banks. We believe this is largely unjustified given our calculation that ANZ’s Australia Retail and Commercial NIM was only down 1bp (excluding the impact of customer remediation) half-on-half.

It actually appears to us that ANZ’s Australia Retail NIM increased from 1H19 to 2H19, which has positive readthroughs for WBC and CBA given that these banks are more skewed to Australian retail banking.

We believe ANZ’s main problems on the margin front are its Institutional and NZ divisions, and more specifically we believe the problem is the compression in margins that ANZ is generating on deposits in these divisions.

We expect domestic and offshore central bank rate cuts to pose a greater problem for ANZ’s NIM (compared with major bank peers) because of the nature of ANZ’s Markets business. 

Partial franking spooks investors 

It appears there is now investor consternation that the other major banks may also reduce their franking percentages.

Our base case is that franking will not be an issue for the other major banks (as it has been for ANZ) for the following reasons:

  • The other major banks derive a greater proportion of their group statutory earnings from Australia
  • The other major banks have healthier surplus franking credit balances.

Investment spend to overtake CBA and WBC? 

Over the past decade, ANZ has invested ~$1.2bn each year in new technology and systems across the Group.

In FY19, ANZ invested a record amount of $1.4bn, and the Company has said that it will invest even more in FY20.

It is conceivable that ANZ’s investment spend will be greater than that of CBA and WBC in FY20 despite ANZ being a smaller business. To us, this highlights the extent to which ANZ needs to play catchup on technology, and we view NAB as being in the same bucket as ANZ on this front.

Investment view and changes to forecasts 

We have reduced our cash EPS forecasts by 11.6% and 12.7% for FY20F and FY21F respectively, largely due to lower NIM forecasts and higher operating expense forecasts. 

We retain a Hold recommendation.

Our target price, based on our DDM valuation, has reduced. (Login to view target price)

More information

To view further analysis, Morgans clients can view the full research note. Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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