Will the big four banks cut their dividends in 2020 and beyond?

A potentially ‘big’ value trap

Value traps are everywhere. That is, stocks that appear cheap, but actually aren’t.

The appeal of these kind of stocks is often an intuitive one. Even more so when interest rates are low and certain companies, like Australia's banks continue to pay market leading dividends.

Writing for Bloomberg, Nicholas Colas, cofounder of DataTrek Research wrote:

‘The historically high price-to-earnings ratios being placed on equities today make cheap stocks even more alluring. That makes sense, but be advised that the market is littered with "value traps" -- stocks that look cheap but never substantially rebound.’

For example, the ANZ share price fell 7% in the last year, while CBA proved the most resiliant of the Australian banks, with its share price rising 17% in that period.

Capital appreciation aside, traditional valuation metrics are currently somewhat above historical averages – particularly in the US. More locally, the idea that Australia’s once thought untouchable big four banks – ANZ, CBA, Westpac and NAB – now represent value, after 2018-2019's sell-down – is one Macquarie Wealth Management recognises, but ultimately rejects.

Specifically, Macquarie thinks that using traditional metrics, such as price-to-earnings ratios to measure the value of the banks may give investors the wrong idea – particularly in the current environment where many concerns still persist.

The below table, which broadly highlights Macquarie’s current views on the big four, includes the estimated percentages which the investment bank expects the big four’s dividends will decline by, between FY20 and FY22.

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As it stands, the investment bank does note that Australia’s banking sector is ‘currently trading at ~14% PE relative discount to its 10-year average, which is broadly consistent with a 10-20% discount for global peers.'

Though trading at a discount to the local market, Macquarie is keen to point out that relative to global banks, Australian banks actually trade at a ~21% premium, on a long-term basis.

ANZ, CBA, Westpac & NAB: share prices and dividends

Yet it’s not just a valuation issue that has caused Macquarie to remain underweight on Australian banks.

Centrally, the investment bank sees an array of issues that explain the big four’s relative ‘cheapness’ to the local market, including continued margin and fee headwinds as a consequence of historically low interest rates, persistent regulatory issues, an intensifying competitive landscape and a subdued credit growth outlook.

Ultimately, it is for these reasons that the investment bank believes the big four's current discount to the market is a justifiable one.

‘In our view, it will be difficult for the sector to outperform the market as earnings and dividends decline, and the downgrade cycle persists,’ says Macquarie.

Looking over the next three financial years and as a consequence of the above, Macquarie expects all of the big four to see dividend declines – ranging from 6% to 17.4%.

According to Macquarie, the Commonwealth Bank of Australia (ASX: CBA) will be the least impacted over the medium-term: with its dividend expected to drop by 6.0% over the next three fiscal periods.

Westpac Banking Corp, by comparison will be most impacted: with the investment bank expecting WBC's dividend to decline by 17.4% – between FY20 and FY22.

Australia and New Zealand Banking Group (ASX: ANZ) and National Australia Bank Ltd (ASX: NAB) are expected to fall somewhere between those extremes in FY20 to FY22 – with forecasted dividend declines of 12.5% (ANZ) and 9.2% (NAB).

‘Banks’ returns are expected to decline by ~0-2% over the longer term as a result of earnings headwinds and additional capital.’

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