Australia's biggest banks don't appear cheap. Across a number of vital valuation metrics, they're riding high. Perhaps the most important figure is a bank's net interest margin (NIM). For each of the big banks, NIMs are near all-time lows.
Our biggest banks, such as Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: WBC), Westpac Banking Corporation (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) are being pressured in the domestic market by smaller rivals such as Bank of Queensland Limited (ASX: BOQ) and Bendigo and Adelaide Bank Limited (ASX: BEN), who are forcing them to compete.
Another factor permanently affecting profitability is customers' choice. Since the big four derive a majority of their earnings from the domestic mortgage market and retail banking clients (perhaps with the exception of NAB who do a large amount of business banking), the introduction of businesses like Mortgage Choice Limited (ASX: MOC) and Homeloans Limited (ASX: HOM) is cutting into profits. These companies offer easy comparisons of the major banks' products and receive a commission for their service, cutting into profits.
An exception to the rule?
Perhaps the exception to the rule is ANZ. Its management, led by Chairman John Morschel and CEO Mike Smith, were able to make strides in differentiating the bank from its peers way back in 2007, when the bank launched its 'Super Regional Strategy'. Since then, investors have waited patiently.
Before we focus on the good stuff, one criticism of the bank's venture into Asia has been the return on investment. Analysts are concerned with the reduced profitability of doing business in an already tightly contested arena. For example, ANZ's overall group NIM is 2.22% (down from 2012), but if you take away its Global Markets business, that figure rises to 2.63%. By comparison, the Commonwealth has a NIM of 2.2%.
On a good thing
The bank's ambition for its Asia, Pacific, Europe and Americas (APEA) division is for it to deliver 25%-30% of group revenue by 2017. Currently it produces 17.2%. However, its $3.18 billion in 2013 represented an increase of 13.5% on the prior corresponding period (pcp), hinting the bank could be onto a good thing.
Another positive factor which Mike Smith brings to the table is patience. Last year when commentators were calling on ANZ to make acquisitions in Asia (alluding to it being under pressure to reach its 2017 target) Mr Smith said the acquisitive targets in Asia did not represent fair value, even though a purchase would have made his target a lot easier. Many CEOs will pursue growth for growth's sake, without considering the sustainability of their business and focus solely on bonuses and share price performance, it's a recipe for disaster.
ANZ is not alone in recognising the value of getting into Asian markets early. Westpac, National Australia Bank and Macquarie Group Limited (ASX: MQG) have each begun to dip their toes into the deep pockets of Asian economies.
What about valuation
ANZ made a hefty $6.498 billion cash profit in FY13, an increase of 11% on the pcp. However after a run-up in share price of 31% for the 2013 calendar year, the price has become demanding. It trades on earnings around 15 times, above its 10-year annual average.
Foolish takeaway
Even if ANZ could emulate the same results in FY14 (11% profit growth), there is more risk built into the price. Coupled with macroeconomic headwinds such as low interest rates (driving a demand for dividend stocks and lowering customers' chances of defaulting on loans), record low bad debts and increased competition in its most lucrative market, it appears the stock is fully valued.
However, if the share price does experience some volatility or setbacks, look to add it to your portfolio ahead of its peers, because its diversified earnings and exposure to Asia are a pathway to success. In the meantime investors could look for other stock ideas such as Macquarie Group.
