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Regional banks get some equality with major banks

Broker reports editor |  08 May 2014  |  Investing

Rural BanksDeutsche Bank has examined two banks, one in the big four and one a regional bank. It provides an interesting insight into the way the two types of banks are evaluated. Deutsche has a hold recommendation on Westpac. It is on a price earnings ratio of 10.4 times and has a prospective dividend yield of 6.7 per cent. Earnings per share growth is about 5%. Its share price has gone up by 2.7% over the last 12 months and the share price has exceeded the All Ordinaries by 6.5%.

Here is Deutsche's assessment:

"Whilst WBC's strong 1H14 result showed good business unit momentum, we believe that there are several headwinds running into 2H14 which is likely to constrain earnings growth to ~1.0% HOH which is at the bottom end of peers. This lower growth will be supplemented by WBC's superior capital position vs peers which expanded further post APRA's change in treatment of WM debt today. Even after including this capital benefit, we estimate WBC's total shareholder return will be in line with peer average, however the stock trades at a 3% premium vs LR avg vs peers suggesting little upside."

Deutsche has a price target of $35.90. The question is where the earnings growth is going to come from:


"We estimate that the factors above are likely to limit cash earnings growth for WBC to ~1.1% and underlying earnings at only 2.2%. This will see WBC’s earnings growth in 2H14 at the bottom end of peers which we estimate are likely to deliver earnings growth of 2 -4%. It’s a similar trend on a 3 year view with WBC 3 year earnings CAGR of 4% vs peers at 5-8%."

Bendigo Bank is on a price earnings multiple of about 10.3 times, which is similar to Westpac. Its dividend yield is also similar, at 6.8%. But it has better growth prospects:

"BEN's announced acquisition of Rural Finance Corporation looks to be a strategically sound and low risk method of building out its Agri banking book. Nonetheless, with the FY15 ROE on the acquired business only 11.5%, we do think this deal is a side show to the more strategically important task of achieving advanced accreditation, which would double returns in the mortgage front book. With the acquisition not moving the dial from a financial perspective, BEN looking fair value vs peers, and with significant risk remaining on Great Southern we have retained our HOLD rating."

It suggests that regional banks have been rerated. They are now getting a similar valuation to the four majors. This can be seen in the share price performance over the last year, which is also very similar to Westpac. Bendigo's share price has risen by 2.7%. Relative to the All Ordinaries it is up 6.6%. Deutche's price target is $12.

In other words, on the basic financial fundamentals, the two companies are relatively similar, despite their very different sizes. It suggests that regional banks are back on a very similar footing -- after the GFC they were treated with great scepticism -- potentially offering investors an option for diversification.




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