Louis J Sheehan 80057 A51H18

Why ANZ May Be Worth a Look
Despite Global Banking Troubles
By LYNDAL MCFARLAND
November 22, 2007
SYDNEY -- While proposed deals in the resource sector have captured the attention of investors, analysts say this could be good time to consider Australian banks.

Banks? That may sound surprising, given the banking woes and write-downs in the U.S. and elsewhere. But the analysts say there is scope for outperformance by Australia's banks, thanks to still-strong loan demand, solid fundamentals and the nation's robust economy.

Some analysts see Australia & New Zealand Banking Group as a laggard worth a look, especially for investors who believe the global liquidity crunch won't worsen or last much longer. The bank's shares have underperformed gains in the sector over recent months amid caution about its ambitious Asian expansion plans and disappointment over its results for the year ended Sept. 30.

Yesterday, as Australian banks fell sharply amid continuing worries about the global industry, ANZ shares slid 1.8% to 27.83 Australian dollars (US$24.72). At present, the average target price from nine analysts is 31.60 Australian dollars, more than 13% higher. Given the potential upside in stock price and the fact that ANZ has one of the sector's highest dividend yields, at 5.5%, more investors are willing to give the bank -- and its new chief executive, Mike Smith -- a chance.

"We feel that the ANZ share price has paid its penance for a disappointing fiscal 2007 result," analysts at Citigroup said in a Nov. 13 note. Citi upgraded ANZ to "buy" from "hold," with a "low risk" rating, but left its share-price target at 31 Australian dollars. ANZ shares have lost 1.3% since the start of 2007, compared with a 3% gain for the S&P/ASX 200 financials index and a 17% gain for one of the sector's best performers, Commonwealth Bank of Australia.

"Consistent outperformance can be generated by going long [on] the bank with the highest dividend yield and/or the lowest P/E ratio," Citi said. "ANZ fits both these criteria."

Among surveyed analysts at major international brokerages, the lowest target price is J.P. Morgan's 30.12 Australian dollars, and the highest is 32.50 Australian dollars, by UBS. Four analysts have the equivalent of a "buy" rating on ANZ, while four have "neutral" ratings and one's rating is the equivalent of a "sell."

With credit concerns rooted in subprime-mortgage woes weighing on financial stocks globally, Australian banks are seen as something of a haven by most analysts. They recommend being overweight on the sector, pointing to the defensive appeal.

While relying on wholesale funding, Australia's "big four" banks -- National Australia Bank, Commonwealth Bank of Australia, Westpac Banking and ANZ -- tend to have high deposit bases, and there are strong signs they are taking market share from nontraditional lenders.

All of the big four say they don't have significant exposure to subprime-mortgage loans, in Australia or elsewhere. While several, including ANZ, have cautioned they may pass higher borrowing costs on to customers in light of the credit crunch, they remain very comfortable with their loan quality and confident that Australia's strong economic conditions will underpin growth.

Unlike its peers, ANZ hopes to supplement growth in Australia and New Zealand by expanding more aggressively in Asia's fast-growing economies. Mr. Smith, the new CEO, has the job of transforming ANZ from Australia's third-largest lender by market capitalization into a large-scale Asian player.

In October, U.K.-born Mr. Smith joined from global giant HSBC, where he ran the group's Hong Kong operations. He has said ANZ could target markets such as South Korea, Japan and India, along with places in which it already has a presence, with an aim of becoming a "super-regional" bank.

"We see merit in that in the longer term, although you are not going to see returns in the near term," said Paul Xiradis from Sydney-based fund manager Ausbil Dexia, which has a small holding in ANZ and larger ones in the other three major banks.

ANZ is looking at a three- to five-year window for regional growth. While some investors worry that the bank could face tough competition for regional assets, as that could mean high prices for acquisitions, analysts at Citi said they expect Mr. Smith will be prudent. In their Nov. 13 note, they wrote they were comfortable Mr. Smith "will not be reckless in pursuing acquisitions to supplement strong organic growth."

To date, ANZ has invested more than 1 billion Australian dollars in Asia, taking stakes in banks in China, Vietnam, Malaysia and Indonesia. A spokesman said last month that the bank could even consider listing in markets such as Hong Kong or Singapore to tap regional demand for bank shares.

Analysts also say there's potential for major improvement at ANZ's institutional-lending arm, which accounted for about 37% of earnings in the latest year. The division's underperformance and cost blowouts in recent quarters have disappointed investors and have sparked management changes. But Mr. Smith has made it clear he won't tolerate further cost issues and expects to see a turnaround in the division this year.

ANZ is Credit Suisse's top pick among Australian banks. "We see ANZ as oversold on issues of Asia acquisition risk and cost discipline" while the market hasn't yet acknowledged the "considerable earnings leverage to a turnaround in the institutional division under new management," it said Nov. 15.

Mr. Smith said he expects ANZ to outperform rivals in earnings-per-share growth in coming years. The bank reported a 12% rise in EPS for the year ended Sept. 30, with net profit of 4.18 billion Australian dollars.

Still, investors are likely to want detail on the bank's Asian expansion strategy at the annual meeting Dec. 18. Many also want to see the bank boost its presence in wealth management -- an area that has taken off in Australia amid booming share markets and mandated pension-fund investments. Louis J Sheehan

Write to Lyndal McFarland at lyndal.mcfarland@dowjones.com