Macquarie smashing the big four

In the past week, we have seen three retail banks: ANZ Banking Group, Westpac Banking Corporation and National Bank, announce disappointing dividend results. 

• ANZ Banking Group delivered zero growth in its H219 dividend and a surprise cut to its franking level from 100% to 70%. 
• Westpac Banking Corporation delivered a 15% cut to its dividend, along with a A$2.5bn capital raising to shore up its regulatory capital position in the face of a tighter regulatory capital regime being experienced by the industry.
• National Australia Bank delivered a 16% decline in its FY19 dividend vs FY18.

More importantly, in nearly all these cases (NAB being the exception at this stage), the Boards of these major banks have essentially rebased their payout ratios to reflect the operating environment they find themselves in.

This environment is one of continued pressure on revenue growth, net interest margin pressure from structurally low interest rates, elevated regulatory costs and higher regulatory capital requirements.

A consequence of this is structurally lower return on equity (ROE) generation, which has a direct influence on bank valuations. ROE’s for the major banks have declined on average by around 500 bps since 2011, reflecting their inability to grow earnings and deliver any growth in dollar dividend generation. This has resulted in a paltry major bank dividend CAGR of only 1.4% since 2011. 

Don't be fooled by what appears to be a 6% yield

When looking at bank valuations, the continued decline in ROE has seen disappointing share price performance for all the major banks. The argument that banks looks attractive due to optically high dividend yields is flawed. 

They have appeared to be offering around 6.0% p.a dividend yield for the last 5 years, when looking 12 months out. 

Yet we have seen dividends cut on average by 2% p.a over that period, only to see the share prices fall to reflect the new dividend environment and rebase at a 6%, 12-month forward projected dividend yield again. 

Earnings under pressure

The lack of dividend compounding and its influence on the total return equation for the major banks cannot be underestimated. Furthermore, Australian major bank earnings will continue to remain under pressure, meaning further dividend cuts cannot be ruled out despite the rebasing by bank boards. 

This backdrop, coupled with further, dilutive capital raisings (equity placements and dividend reinvestment plans) will continue to place pressure on bank valuations.

Major Bank payout ratios – Little room to move

Source: Ellerston Capital

Macquarie is a different animal completely

The contrast is stark when compared with Macquarie Group (MQG), which recently announced a positive interim dividend surprise, with growth of 15% on pcp. 

When looking at the ROE trajectory of Macquarie Group, it represents a total contrast to the major banks. MQG’s ROE has expanded from 8.5% to 16.5% since 2011, an 800 basis point improvement. The resultant earnings generation has seen dividend per share CAGR of 15%. 

Macquarie Bank’s earnings are uniquely leveraged to rising asset values and strong investor demand for its infrastructure funds (MIRA). As opposed to the major banks, much of MQG’s shareholder value is generated from the high growth / low capital intensive MIRA infrastructure management business within Macquarie Asset Management. 

Optically, Macquarie Group has been priced on around a 4.3%, 12-month forward dividend yield but positive dividend surprise has seen the share price rise to reflect the new, higher dollar dividend trajectory rebase. 

The key point to make here is that the running yield on the four major banks on stock purchased 5 years ago is now around 5.1% p.a vs 9.2% p.a for Macquarie Group. Looking simply at 12 month forward optically high dividend yields can be deceiving if business models are under pressure. This highlights the point very clearly. 

From a total return perspective, not surprisingly, over the past 5 years, the major banks on average have underperformed the ASX 200 Accumulation Index by 39% compared to Macquarie Group outperforming the index by 140% over the same period.

In summary 

Around three months ago we foreshadowed the risk to major bank earnings and dividends given the structural and regulatory pressure their businesses were experiencing.

Many income investors continue to focus on nominal yields over dividend growth and sustainability. Traditional banking business models are being disrupted by technology, competition and regulation, eroding the sustainability of earnings and dividend growth. 

Income needs to be looked at through a different lens, focusing on those companies that can adapt to changing business conditions and continue to deliver profitability and sustainable dividend growth to capture the true benefit of compounding income generation. 

The major banks, when compared to Macquarie group is an outstanding example of this and is why the Ellerston Low Volatility Income Strategy (ELVIS) is still very underweight the major banks whilst having a meaningful overweight portfolio position in Macquarie group. This strategy continues to deliver meaningful portfolio return results.

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