Adjustments to the Blended Australian Equity Portfolio
Purchased Westpac Bank (WBC)
We have initiated a position in Westpac, adding to the existing bank holding in CBA but remaining considerably underweight the sector. Our prognosis for the banks is they are in a trough phase rather than fully fledged recovery. The decision to increase exposure to banks, albeit off a very low position, is driven by the prospect that we are close to seeing a base in margins and capital, while the economy is in nascent recovery. The laggard relative performance of the sector, having underperformed the ASX200 by 38% on a rolling 3 years, 20% on a rolling 12 months and 23% since the COVID-19 market low on 23 March 2020 is useful in context but not a reason in and of itself, for the same argument could have been made more than a year ago. Margin - Net interest margins in 3Q20 declined for all the major banks, however the outlook for margins following this deterioration is relatively stable due to the ability to maintain loan spreads in a low interest rate environment, the lower cost of bank bill funding and interest rates on term deposit funding rolling lower. The retail franchises of CBA and Westpac have a greater capacity to manage margins due to their retail deposit funding and exposure to consumer lending. Capital - The capital position of all the banks should remain above the “unquestionably strong” requirement of (CET1) 10.5% where at 30 June CBA and NAB had the strongest positions at 11.6% with ANZ and Westpac trailing at 11.0% and 10.8% respectively. Westpac’s position could benefit from the capital released from asset sales, while Westpac has the lowest proportion of home loans in deferral at 7% versus 10-12% for the other banks. Recovery - The first element of Westpac’s recovery is the $1.3b AUSTRAC penalty, which was $400m higher than the existing provision in its accounts, but smaller than many market estimates of ~$1.5b. This marks the end of a process of renewal at Board and management level for Westpac and hopefully the organisation can set about its recovery free of such distractions. Banks are yet to see loan growth rebound and the loan loss cycle from COVID-19 is set to emerge, however Westpac is trading on a trailing price to book value of ~0.9 times (vs 10 year average 1.7x) and a pre-provision earnings multiple of 5.4 times (vs 10 year average 8.5x).
Adjustments to the Australian Equity Income Portfolio
Reduced Chorus Limited (CNU) & ASX Limited (ASX)
We have sold a portion of the Chorus and ASX Ltd holdings to fund the addition of Westpac. Chorus has exceeded our expectations of price performance, returning more than 40% during 2020 versus the market return of -11% and now trades on a forecast dividend yield of circa 3.2%. We remain positive towards the company and its outlook, but the share price could lag in the event of a broader economic recovery.
ASX has had a positive return of 8.3% during 2020 and similarly we would expect it to underperform in a broad- based recovery, however its sovereign infrastructure characteristics remain attractive.