ASX code: ANZ
Share price: $26.51
Industry: Banking & Investment Services
Forecast FY2017 Dividend: 163.0 cents fully franked
ANZ’s turnaround under new CEO Shayne Elliott is working and income investors should take notice. Many SMSF investors seek adequate income and moderate, low-volatility capital growth. ANZ is one of our preferred stocks for these objectives because the strategy to de-risk the bank by shrinking the volatile institutional (large corporate) loan book is not only driving the share price higher, it increases our confidence future dividends will be steady – especially now the dividend has been rebased lower to more sustainable levels.
ANZ cut its FY2016 interim dividend seven per cent to 80 cents and guided to a final dividend at least the same as the interim. We think incremental growth to a dividend of 163 cents is realistic for FY2017, which puts the stock on a forward yield of 6.1 per cent fully franked. This is attractive in a world of 2.5 per cent term deposit yields. We expect general banking and economic conditions to remain stable, so the yield should support the share price.
Until now we have not reviewed ANZ in Dividend Detective because the dividend payout ratio, or the proportion of earnings ANZ paid as dividends, was too high for a bank with an institutional loan book prone to negative surprises like higher bad debts. We thought ANZ would have to cut its dividend and this happened. ANZ now plans to gradually lower its payout ratio from the current 75 per cent to 60-65 per cent in coming years. It can do this without cutting the dividend further because total earnings are stabilising and supported by cost savings and the reweight from Asia to the more profitable Australian market.
ANZ is trading around nine per cent below our $29 valuation, which reduces capital downside and highlights the opportunity in the stock. Value investors rationally choose a ‘margin of safety’, or discount to value, at which they would buy a stock and a 5-10 per cent discount arguably is consistent with the degree of risk in ANZ at the moment. The bank was undervalued for the entire eight years (2007-15) of the Asian super-regional expansion because the strategy reduced return on equity and increased earnings volatility and the market correctly priced this in. Now the strategy has changed to something more shareholder-friendly, the discount to value has already closed markedly.
No investor should expect strong share price appreciation and dividend growth from ANZ (or any other bank). Outside mining and dairy regions, credit quality in the Australian economy is generally good but demand for credit is growing only slowly. This reflects similarly weak domestic economic growth, a slowdown in residential investor lending enforced by the regulator APRA and excessive hurdle rates of return for new investment projects at companies. Hurdle rates have not fallen since the financial crisis, despite historically low business lending rates, and this is dampening business investment.
But the dull demand for credit also increases our confidence ANZ can hold its dividend despite the demands of regulators for banks to become ever more strongly capitalised. When bank lending grows only slowly, banks do not need as much shareholder capital to back these loans for prudential purposes, which releases more capital for paying dividends. The reduction of ANZ’s institutional loan book adds to this effect. Underlying Tier 1 equity capital at the end of the third (June) quarter surprised on the upside by rising 44 basis points or 0.44 per cent to 9.7 per cent of loans. APRA’s minimum is 8.0 per cent and ANZ’s internationally comparable Tier 1 ratio is well within the top quartile of banks globally. There are no immediate capital pressures here.
David Walker is Senior Analyst at Clime Investment Management.
Originally published in The Australian, Tuesday 23rd August