The hidden value in financials: 2 quality plays beyond the big banks

While the Big Four banks have surged since 2024, valuations look stretched, prompting fund managers to look further afield in the sector.
Stephanie Gardner

Livewire Markets

Since 2024, the Aussie financials sector has been a standout performer, thanks largely to Australia’s big banks, which have been up ~22.8%. But with bank valuations now rising, easy gains may already be behind us.

That’s the view of Joshua Freiman, Equities Analyst at Investors Mutual (IML), who argues investors should look beyond the major lenders to find more sustainable, long-term value in the sector. 

Freiman gives his valuable insights on the Aussie financials sector performance, growth opportunities, key risks and the stocks he believes offer value right now.

Joshua Freiman, Investors Mutual (IML)
Joshua Freiman, Investors Mutual (IML)

Is there any value to be found within the banks? What are some preferred names?

Banks have been amazing outperformers since the start of 2024, up ~25.5% vs the ASX300 up till 31st July. While their earnings have been more defensive than expected due to benign bad debts, their valuation multiples have expanded materially, and far beyond that of other sectors and even global banking peers. 

As a result, banks are trading well above historical average multiples, despite cyclically low bad debts. Concurrently, the outlook for banks is looking more challenged as bad debts normalise, declining rates drag on deposit margins, and competitive intensity accelerates in the most profitable SME lending segment. 

In our view, bank valuations leave investors with asymmetric downside risk, particularly in an environment where momentum appears to be the key driver of stock performance.

On a stock specific view, we remain underweight banks, but with exposure to Commonwealth Bank of Australia (ASX: CBA) as the leading quality company in the sector and National Australia Bank (ASX: NAB) due to its greater skew towards the profitable and defensive SME segment. 

ANZ Group Holdings (ASX: ANZ) looks interesting, but difficult to predict in the environment with a new CEO beginning his tenure in the midst of a significant integration and transformation program.

12m FWD PEs: Multiple vs Global peers

Source: FactSet, IML

Source: FactSet, IML

Where are the biggest growth opportunities for Australian financials?

While not a material growth opportunity for banks, we see wealth management as a key growth corridor with respect to Australian Financials. Some such stocks are not traditional financials, usually being characterised by high capital demands and leveraged balance sheets. 

In contrast, the wealth management and platforms businesses such as HUB and Netwealth benefit from operating leverage and are capital-light. 

We see significant opportunity for growth underpinned by structural changes, primarily the ageing working population shifting to the pension phase for their superannuation. 

As this structural shift occurs, we expect an increase in population demand for financial advice over the next 10 years. Additionally, platform fees have been rebased as competition has increased, leaving a more stable revenue model that can now benefit from growth in market balances. 

With low capital requirements for growth (a “capital light model”) and operating leverage, this revenue growth should translate into consistent growth in cash flows.   

What are the key risks when investing in financials?

Again, financials are primarily balance sheet driven companies, and traditional financial sectors such as lending and insurance require capital to be kept by the regulator. 

Growing their businesses requires retention of capital, which can be difficult in a time of economic uncertainty, due to bad debts or asset write-downs. Financial businesses are economically sensitive but can behave through the cycle. 

Take banks versus insurers:

  • Banks will suffer reduced earnings on the back of lower lending growth, higher funding costs, and increasing bad debt risk, leading to a higher probability of capital raises / dividend cuts.
You would therefore expect banks to underperform in a prolonged cycle.
  • There is also the risk of a liquidity crunch, although Australian banks are well insulated relative to global peers with higher capital ratios and a history of government intervention.

  • Insurance businesses will suffer reduced earnings driven by lower investment yields, rationing of reinsurance capacity at higher prices, and rising claims costs for economically sensitive insurance classes and fraudulent claims.

  • That said, the insurance cycle is also driven more by the availability of reinsurance capacity, which fluctuates with catastrophic events, independently of the economic cycle, and should generally perform better than the banking/lending sector.

Which financial stocks are you backing right now?

It feels like slim pickings in the financials sector, but we see a couple of areas of medium to long-term value:

Steadfast Group (ASX: SDF)

Source: Market Index
Source: Market Index

There is a lot to like about the insurance brokers in the financials space, given SME insurance premiums are much less cyclical than commercial premiums more generally. The standout is Steadfast.

Not only are brokers winning share from direct insurance distribution, but SDF is winning share amongst SME brokers. It’s the largest broker and underwriting agency, providing essential, non-discretionary cover with ~95% client retention.

Since the 2013 listing, SDF has delivered ~13.5% annual earnings and dividend growth, fueled by steady mid-single-digit SME premium expansion. Their investment in tech sees them as an industry leader with seamless quoting and binding through their client trading platform, supporting 23 agencies that place over $1.5bn in premiums annually.

Their bargaining power with insurers is improving, and they are creeping up the value chain through specialised underwriting agencies.  

Plenty of levers to grow earnings without taking the balance sheet risk you face with other financials like banks and insurers.

Macquarie Group (ASX: MQG

Source: Market Index
Source: Market Index

MQG is well-positioned relative to the other banks, with exposure to long-term trends including structural growth in infrastructure spend required across the US and EU, decarbonization, and globally connected energy markets.

We’ve seen some earnings disappointments in the last 18 months, and short-term earnings volatility driven by energy and commodities trading, which has been benign up until recently.

Despite these short-term disappointments, MQG remains well-placed to benefit from a reducing rate environment, with improving transaction activity and asset realisations set to drive higher earnings in both the MacCap and MAM divisions.

MQG is relatively inexpensive, putting it in a good position to outperform major bank peers on a ~3-5 year view.
Managed Fund
Investors Mutual Australian Share Fund
Australian Shares
Managed Fund
Investors Mutual Australian Smaller Companies Fund
Australian Shares
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This publication (the material) has been prepared and distributed by Natixis Investment Managers Australia Pty Limited ABN 60 088 786 289 AFSL 246830 and includes information provided by third parties, including Investors Mutual Limited (“IML”) AFSL 229988. Although Natixis Investment Managers Australia Pty Limited believe that the material is correct, no warranty of accuracy, reliability or completeness is given, including for information provided by third party, except for liability under statute which cannot be excluded. The material is for general information only and does not take into account your personal objectives, financial situation or needs. You should consider, and consult with your professional adviser, whether the information is suitable for your circumstances. Past investment performance is not a reliable indicator of future investment performance and that no guarantee of performance, the return of capital or a particular rate of return is provided. It may not be reproduced, distributed or published, in whole or in part, without the prior written consent of Natixis Investment Managers Australia Pty Limited and IML. Statements of opinion are those of IML unless otherwise attributed. Except where specifically attributed to another source, all figures are based on IML research and analysis. Any investment metrics such as prospective P/E ratios and earnings forecasts referred to in this presentation constitute estimates which have been calculated by IML’s investment team based on IML’s investment processes and research. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to either buy, sell or hold that stock. Any commentary about specific securities is within the context of the investment strategy for the given portfolio.

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Stephanie Gardner
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Livewire Markets

I'm an editor at Livewire Markets, with a passion for financial and investment education. With my background in funds management and a passion for making investment knowledge accessible, I am dedicated to crafting engaging content that empowers...

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