Retail Headwinds

The first-half FY19 result recently reported by ANZ Banking Group was very close to Ord Minnett’s forecasts at every line, with strength in the institutional business saving the blushes of an underperforming Australian retail banking division.

 

Cash earnings of $3.564bn were broadly in line with our estimate after adjusting for lower-than-forecast remediation costs and higher-than-expected gains on asset sales, while the interim dividend of $0.80 per share, fully franked, was right in line.

 

The 2.8% share price rise on the day of the result, versus the S&P/ASX 200 Index’s gain of 0.8%, likely reflected management’s cost base target of $8bn by FY22 – implying much better cost control than we had forecast – and low market expectations.

 

We make the following observations:

 

  • The institutional operations delivered a return on equity of just under 11%, a figure that is expected to improve further. In our view, however, it will take longer than we had previously expected to turn the retail bank business around and, although the capital surplus is healthy, ANZ faces greater exposure than its peers to proposed higher regulatory capital requirements in New Zealand.

     

  • The bank’s new cost-savings target is well ahead of our previous estimate. CEO Shayne Elliott stated an $8bn cost base target by FY22. We estimate this implies a compound annual cut in expenses of 2% over the three years from FY19 to FY22. We assume a fall of 1% in underlying costs in FY20 and FY21.

     

  • Organic capital generation was strong again at 84bp. The core equity tier-one ratio of 11.5% implies about $4bn of surplus capital, which should rise further on completion of the Australian life business sale, although these funds will be required for higher New Zealand regulatory capital requirements.

     

  • On asset quality, gross impaired assets were flat, while new impaired assets fell 22% half-on-half. However, delinquent and past due loans of 90 or more days continued to deteriorate, with Australian home loan arrears reaching 100bp. Home loan losses remained low at 4bp, but these could rise further from here.

We have raised our FY19 cash net profit forecast by 2%, but cut our estimates for FY20 and FY21 by 25 and 0.4%, respectively. The above factors, along with execution risks and the recent strong share price run, have led us to downgrade our recommendation to Hold from Accumulate and our target price to $29.50 from $31.20.

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