Westpac Banking Corp (ASX: WBC) shares were out of form on Thursday.
The banking giant's shares ended the day almost 1% lower at $26.87.
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Why did Westpac shares fall?
Investors were hitting the sell button after analysts at Goldman Sachs downgraded the bank following a review of the sector.
According to the note, the broker believes bank valuations "are at extremes" at present. It said:
Australian bank valuations are at extremes, with absolute 12-month forward PERs at the 99th percentile, our DCF valuations are, on average, 175% below current share prices, and the spread between bank fully-franked yields and the 10-year bond yield is currently at its lowest level in nearly 15 years.
The broker concedes that versus industrials the bank's don't look expensive. It adds:
However, the one metric where valuation support for the banks still exists is how their PER trades against the non-bank industrials'. On this basis, while the sector has re-rated significantly over the past 12 months, it continues to trade nearly 5% below longer-run historic averages.
Though, it feels this approach to valuing the banks is flawed. Goldman explains:
However, the above analysis is overly simplistic and takes no account of how relative fundamentals between the banks and non-bank industrials may have evolved over time. On this front, the recent reporting season did show that the pace of deterioration in bank fundamentals does appear to be slowing. However, our analysis suggests we should not be expecting a material improvement in fundamentals from here.
So, while the deterioration in earnings appears to now be finished, we see very limited upside risk, and therefore, with valuations skewed asymmetrically to the downside, we now think a more negative view on the banks is appropriate.
Westpac downgraded
In light of the above, the broker has downgraded Westpac shares to a sell rating (from neutral) with an unchanged price target of $24.10.
Based on its current share price of $26,87, this implies potential downside of over 10% for investors over the next 12 months. It concludes:
WBC to Sell from Neutral, given i) execution, cost and timing risks relating to its technology simplification, ii) of the major banks, WBC's balance sheet is the most overweight domestic housing, which we expect will be more growth constrained than commercial lending over the medium term, iii) NIM has been supported by a shorter duration replicating portfolio but this will give them less longevity, and d) WBC's 14.2x 12-mo fwd PER is more than one standard deviation expensive vs. its 12.7x historic average.
