Market Price: $1.73
Current Value ~ $2
Future Value FY1: ~ $2.25
Future Value FY2: ~ $2.30
Pioneer is an Australian financial services provider, specialising in acquiring and servicing unsecured retail debt portfolios. Customers are in financial difficulty, mainly due to major life events such as unemployment, marriage breakdowns or significant health issues. PNC's debt purchases focus predominantly on credit card and personal loan accounts that are usually more than 180 days overdue.
A positive catalyst based on their recent announcement that Pioneer Credit had signed a forward flow agreement with a major bank failed to be impounded into the stock price. By securing the forward flow agreement, the company has fulfilled customer acquisition expectations that supported its FY15 forecast outlined in their IPO prospectus. As a result of this agreement, Pioneer has agreements locked with three of the Big 4 Australian banks as well as a variety of smaller lending institutions This will support long term sustainable earnings growth as debt purchases increase. Forward flow agreements from debt sellers as well as its unique business model will drive profits over the next few years, particularly as its funding is established and ease of strategy execution. The fact the announcement failed to be supported in share price rises is surprising given the fact their share price dropped from $2 in March to a low of $1.45 in May. Analyst forecasts also expect EPS to be 14.6cents, making a PE multiple of 15.4 based on their 12 month price target of $2.25. Such expectations are in line with Managing Director’s confirmation that they were on track to achieve a net profit of $6.6 million this financial year. Because it will deliver EPS growth of 36.6% in FY15, it has high room for growth as it is trading at a high discount to its target.
Based on historical performance, 85% of debt purchased by PNC was from one financial group. If this client’s forward flow agreement were gone, supply of debt and hence earnings growth would drastically reduce. However, its new clients provide effective diversification and reduce risk. Nevertheless, availability of debt to purchase for its portfolio is highly dependent on the bank’s potential and agreement to sell to PNC, hence the need for forward flow agreements. This risk is increased due to increased competition which would pressure margins. Fortunately PNC has indicated its strategy includes broadening its product and service offerings. The increase in CAPEX would spur long term performance. However, investments would come at higher costs in the future given heavier regulations and higher compliance costs in the regulatory environment. There is limited information regarding implications of company strategy, for instance, limited understanding of whether their asset purchases which increase market share would hamper future performance.
Market Price: $32.25
Current Value ~ $37
Future Value FY1: ~ $36
Future Value FY2: ~ $38
Australia and New Zealand Banking Group operates in Banking and Financial services and serves approximately 10 million global customers on retail, business and corporate clientele levels. The company operates in 33 countries across Asia Pacific, Europe, Dubai, USA and Asia. Australian operations make up the largest part of ANZ's business, dominating with commercial and retail banking lines. Operations extend across the Asia Pacific, Europe, Dubai, USA and Asia. Their strategy involves growing its Asian Pacific operational presence until 25-30% of earnings are sourced from the non-core APEA region by 2017.
In the first half of financial year 15, cash profits rose by 5% and statutory profits rose by 3%. Flexible and accommodating credit conditions are highlighted through ANZ’s record low 0.19% loan impairment relative to total loans. Provisions likewise dropped below their 25-year average to 0.47% of assets. However in the long term earnings will suffer once such provisions and bad debts revert back to historical means. These expenses cannot fall much further, indicating banks have reached their peak of cyclical profitability. Their peak was strengthened by the favorable economic climate and strong property prices. Concerns over bubbles imply increased regulatory capital requirements, especially as the average financial leverage for Australian banks is relatively high compared to international banks at 17x. ANZ’s financial leverage ratio sits lower at 16.5x. However, its Tier 1 Common Equity ratio (which ensures banks have a buffer to access funding in financial crises) has decreased by 0.1% to 8.7% of risk-weighted assets, 0.2% below its 9% goal. NAB and Westpac have already increased their ratio due to anticipation of APRA’s increased capital regulations. Reports indicate Australian banks must boost their capital ratios by an average of 1.4% to be on par with the top global quartile with regards to capital. Regulatory changes combined with a slowdown in economic growth and rising interest margin pressures from competitive forces means ANZ must outperform in their operations. They are experiencing increased market share from their expansion in the Asia Pacific, where deposits and loans are growing. ANZ reaps benefits from large market cap and reputation in the wholesale deposit and funding markets and its operations in Australia’s secure socio-legal environment, as it ensures raising funds at cost effective prices. Its super regional strategy has so far been effective as profits from Asia Pacific represent 25% of total group earnings, and international and institutional banking (IIB) profits are increasing. Interim dividends were 4% higher than the first half of financial year 14 at $0.86.
ANZ has experienced slow progress in their super regional strategy in creating an Asia Pacific connected bank. They are effectively diversifying group earnings by capitalizing on the international shift in focus on Asian emerging economies, though key risks include increased competition from global banks, slowing of Asia’s economic growth (compounded by Chinese equity market bubble and crash) and returns have rarely historically been over the cost of capital. Lesser provisions also increases risk in an economic downturn, especially as reversion in impairment depends on cyclical economic factors such as low unemployment and interest rates which maintain quality credit conditions. Such reductions in boosting earnings cannot be sustainable meaning operational revenues must grow and the company must drive cost efficiencies in their regional strategy. However it is unlikely there will be rate hikes over the next FY.
Market Price: $17.40
Current Value ~ $19
Future Value FY1: ~ $17
Future Value FY2: ~ $22
Magellan Financial Group is a Sydney based specialist investment management business. Their asset management business line offers global equities and infrastructure investment funds for high net worth, retail and institutional investors in Australia and New Zealand.
Their performance fee revenue of $33 million is a substantial increase of 1623% from last FY results, which drove revenues to increase by 91% to $128 million. This boosted NPAT margins to $77 million, up by 115%. Considering only 35% of total funds in management is subject to performance fees, there is room to build on this revenue growth. Funds in asset management increased from $23.4 to $31.6 billion due to growth in US (accounts for 25%) and UK (accounts for 49%) institutional clients. Australia accounts for 16%. Future growth is determined by the performance of funds in management, though based on 3 and 5-year historical performance, Magellan funds performed in the top quartile relative to competitors. Leverage also rises as there is a higher ratio of fixed costs relative to variable, and there is limited capital in their operational model. This will spur profit margins. Retail investors reap higher margins in management fees, though retail investors only account for 27%. Magellan Global Equities (MGE) is essentially a duplicate of their main retail fund though offers a catalyst in terms of extending retail distribution over fund platforms used by investment advisors, enabling self-investors convenient access to funds. Positively, growth in their distribution team will ensure higher retail sales, helped by the increase in net assets by 113% to $74 million. Moreover, they have been increasing self-managed super funds to international shares, which have appealed to clients. In Australia the minimum legislative requirement on super is set to rise from 9.5% to 12% by 2019. Their successful operations in London where over 90 clients have provided funds can easily be replicated in the US with its new management team. Their recent platform integration with AMP and Westpac for funds management will strengthen Magellan’s relations and reputation with investment advisors in Australia. However, 54% of funds are invested internationally without hedging against exposure to depreciation. Presently record low interest rates from quantitative easing in Europe, Asian and Americas from slowing economic growth spur net inflows for stocks due to the relatively lower returns in fixed income such as bonds and cash. Their business is likely to expand with such inflows in the long term as it is widely expected such rates will stay low.
The key risk involves effects on performance from stability in global equity markets and interest rates. In FY15 there has been increased allocations towards the cash asset type (weighted average of 11% compared to post GFC weighted average of 4%) due to recent global market instability and worries over interest rates. Performance risk is emphasised for Magellan due to relatively higher institutional mandates, which encompass a higher number of retail clients who will withdraw funds in times of poor investment returns. Currently, fund managers typicaly allocate 30% of self managed super fund capital to international shares, however Magellan has less than 0.5% in this asset type. Whilst this mitigates risk of global instability, it must increase substantially to ensure sufficient retirement capital.
Market Price: $33.78
Current Value ~ $36
Future Value FY1: ~ $36
Future Value FY2: ~ $39
National Australia Bank (NAB) is one of the four largest financial institutions in Australia in terms of market capitalisation and customers. They operate in Banking and Financial services. Their provision of products and services is mainly for Australian customers though their operations extend to Asia, UK, US and New Zealand. The group has multiple brands to market various products to different segments. Globally, their corporate business falls under National Australia Bank. In Australia, brands include NAB and UBank for banking, MLC for wealth management and insurance.
NAB also reaps benefits from large market cap and reputation in the wholesale deposit and funding markets and its operations in Australia’s secure socio-legal environment, as it ensures raising funds at cost effective prices. Like all banks, it has reached the peak of cyclical profitability due to historically low bad debts expense (loan impairment charges at 0.18% of loans and provisions are 0.39% of assets, much lower than historical average) and the high likelihood of increased capital requirements and competitive pressures. Increased bad debts and provisions is strongly correlated with decreased returns. As bad debts cannot feasibly decrease further, the focus is on banking income to increase dividends and satisfy shareholder expectations, given its final 99c dividend was unchanged from prior FY. Interest margins are under pressure, with a group contraction of 1 basis point from FY14 due to lower earnings from assets, however NAB offset this by increasing statutory profits by 20.4% and cash earnings increased by 5.4% compared to the previous first half of FY14. 14% of earnings increase was attributed to loan impairments expense, though NAB’s main banking business in Australia increased cash earnings by 4%, largely driven by revenue growth from increased lending to households and businesses. Moreover, NAB combats regulatory risk by providing $5.5bn capital via a 2 for 25 pro rata accelerated renounceable entitlement offer to UK franchises to guard against losses, as they are exposed to macro trends in the UK, particularly with regards to commercial property. This means shareholders will have the right to purchase 2 shares for every 25 they own at $28.50 each. As expected with rights issues, EPS is falls by 4.5% and Return on Equity falls by 1.4%. If losses from compliance to regulations extend beyond the minimum required by the UK’s Prudential Regulatory Authority, the proportionate amount of increase will boost NAB’s CET1 ratio. This implies higher regulatory capital allocations pressures profit margins though reduces risk, supporting the relatively low required returns for the Australian Big 4 banks. NAB’s latest CET1 ratio is 8.87%, an increase from last FY though shows potential for improvement from the rights issue, particularly as its target range is 8.75%-9.25%. Increases in the CET1 ratio will also be driven by NAB’s divestment of underperforming British subsidiary Clydesdale, exit of its Great Western stake and UK commercial real estate. Its demerged asset of 70-80% of Clydesdale to shareholders, sold via IPO to institutional clients will list on the LSE, allowing increased focus on profitable segments such as Australian banking and wealth management lines. Risk reduction is good news as Australian banks have high leverage relative to international banks, with NAB at 19.5x leverage (Australian mean 17x).
NAB has a large 33% sector exposure to emerging recovery in business lending. Previous key drivers of banking credit growth and real estate investor loans is likely to hit its peak due to the upcoming stricter regulatory environment. With low interest rates and the Australian dollar set to hit US65c, there will be less pressure in the business sectors of the economy and hence boost business lending. As common across the banking sector, there will be a reversion of impairment and provisions, though slow credit growth means this risk is not a large one. Impairment risks are further offset through low corporate leverage, attractive asset prices due to sustained low interest rates and global liquidity and minimal exposure to the slowdown in the mining sector in Australia.
Market Price: $34
Current Value ~ $34
Future Value FY1: ~ $35
Future Value FY2: ~ $37
WBC is one of the Big 4 Australian banks that provides financial services. Westpac has Australia’s largest branch network in terms of branches and ATMs. It is the second largest Australian bank by assets, and second largest bank in NZ. Global finance capitals also host its offices including London, New York, Singapore and HK.
Westpac’s strengths include its strong domestic network, conservative lending amounts, high liquidity and scale as well as strong interest margins. It is also reaching the peak of cyclical earnings given low interest rates and record low bad debts and provisions. Strong credit conditions meant impairment charges were only 0.11% of loans, and provisions accounted for 0.45% of total assets, much lower than historical means. Low interest rates will continue to ensure credit quality and credit growth in the medium term. However, banks are leveraged to cyclical conditions, which will remain subdued. The risk of unexpected downturns where unemployment increases and businesses fail, particularly in key cities such as Sydney and Melbourne (majority of home loans on the Big 4’s balance sheets), is unlikely. Its leverage is at 16.1x, which is lower than Australia’s mean of 17x. Westpac mitigates future regulatory risk where there will be increased capital requirements- the company will use an underwritten dividend reinvestment plan at 1.5% discount to raise approximately $2 billion of capital to shift its CET1 ratio towards the higher end of their target spectrum. Their CET1 ratio is recently at 8.76%, lower compared to FY14. Its recent financial results for first half FY15 was below expectations by 12%- profit remained flat with only a 2% increase in cash earnings. There was also a methodology change relating to adjusting a derivative valuation, which decreased non-interest income by 4%. Net interest revenues increased 5% due to a 3% increase in interest earning assets and their interest margin holding at 2.01%. Household debt being over 150% of disposable incomes means credit does not hold expansion potential. However, their 60% investment in BY Investment Management offers a catalyst based on growth in superannuation funds.