Pioneer Credit
Valuation
Market Price: $1.73
Current Value ~ $2
Future Value FY1: ~ $2.25
Future Value FY2: ~ $2.30
Business
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.
Analysis
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.
Key Risks
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.
ANZ
Valuation
Market
Price: $32.25
Current Value ~ $37
Future Value FY1: ~ $36
Future Value FY2: ~ $38
Business
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.
Analysis
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.
Key risks
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.
MFG:
Valuation
Market
Price: $17.40
Current Value ~ $19
Future Value FY1: ~ $17
Future Value FY2: ~ $22
Business
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.
Analysis
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.
Key Risks
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.
NAB
Valuation
Market
Price: $33.78
Current Value ~ $36
Future Value FY1: ~ $36
Future Value FY2: ~ $39
Business
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.
Analysis
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).
Key Risks
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.
WBC
Valuation
Market
Price: $34
Current Value ~ $34
Future Value FY1: ~ $35
Future Value FY2: ~ $37
Business
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.
Analysis
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.
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