HOW WE COMPARE ‘THE BIG FOUR’

Australia’s “Big Four” banks collectively representing more than 40% of the Australian Securities Exchange (ASX). Historically the banks have been a safe haven for investors seeking a reliable income stream. In the last 12 months shareholders have also enjoyed exceptional share price growth averaging more than 25%.

Which bank stands out for its history of consistent growth, steady dividend stream, efficiency and good cost control over the past 12 months? And which bank is well positioned to continue rewarding its shareholders. Is it one of Australia’s Big Four, or should investors expand their investment universe offshore?

Historically, Westpac is a stand out in two categories: Its Cost to Income Ratio is the lowest of the Big Four at 43.2%. Skaffold’s Cost to Income Ratio examines management’s ability to control costs relative to income and Skaffold prefers banks generating a Cost to Income Ratio of less than 50%. Despite growing home loans at a slightly slower pace than its major competitors, Westpac also wins on its impressive Bad Debts Ratio, sitting at -14%. Low or negative change indicates high-quality borrowers and improved lending practices.

However when it comes to return on assets, CBA at 1.0% marginally outperformed Westpac, the top performer in this category last year (with 1.1%), which achieved 0.9 %. Return on Assets is an efficiency measure for banks that assesses profitability of its assets, such as mortgages and Skaffold prefers banks generating on Return on Assets greater than 0.8%.  Lower losses on bad debts has given Commonwealth Bank some badly needed room to compete for new business and still remain profitable, however it has been under considerable net interest margin pressure this year.

National Australia Bank and Commonwealth Bank took out line honours for bank efficiency with a Net Interest Margin of 2.1%. Net interest margin is interest income from the bank’s loan book, less interest paid out to depositors and all Big Four banks exceeded Skaffold’s preferred ratio of 1.8%. While Westpac has historically been the strongest of the Big Four, a recent deterioration in its performance is reflected in more modest growth projections, with Skaffold forecasting underlying value to increase by only 4% per annum over the next two years. By comparison, Skaffold expects per annum growth from CBA and ANZ of 5%, and NAB 7% (based on improving performance) over the next two years.

Skaffold interprets a company’s history of balance sheet quality and business performance in the Skaffold Score, which ranges from A1 to C5. The best companies are rated A1 and green. Poor quality companies are red and rated C5.

Based on its latest financial results, CBA is the only Big Four to achieve Skaffold’s highest A1 rating. ANZ is rated A2, Skaffold’s second highest score for balance sheet quality and business performance. Following its A1 score last year, Westpac was re-rated to A3 due to declining business performance, while National Australia was again rated A4.

The Big Four – value vs price

Using consensus analyst data, Skaffold estimates the value of NAB to be $26.76, which is a 14% discount to the 16 August 2013 Market Price of $31.27. Based on ANZ’s market price of $29.45 (as at 16 August 2013) it is trading at a 9% premium to Skaffold’s 2013 forecast valuation estimate of $26.77. Similarly, both CBA (16 August market price $73.30) and Westpac (16 August market price $31.26) are trading on premiums of 19% and 22% to their respective forecast valuation estimates of circa $59 and $24.

The Big Four are expected to maintain steady dividends streams above a yield of 5%, with NAB and Westpac having paid the highest yields of 6%.

Chris Batchelor CFA is Skaffold’s General Manager.

Chris is a specialist in equity markets and securities. He is a Chartered Financial Analyst and has 20 years’ experience in financial markets.