The banks and supermarket retailers dominated financial market developments in Australia over the past week. Investors were disappointed by full year results from ANZ and NAB, with the stocks falling by 6-7% over the week. Evidente discusses (again) why the lift in capital requirements does not amount to higher input costs for the banks. Analysts have downgraded the sector’s dividend outlook for a while now, due primarily to the fact that the majors are no longer receiving the big free kick of lower bad & doubtful debt charges. Woolworths was down 13% following another profit warning, while Wesfarmers was part of the collateral damage of what appears to be a renewed supermarket price war. With the new Woolworths Chairman having swept the slate clean, I suggest that the downside risk to Woolworths is limited. Renewed strong competition amongst grocery retailers augurs well for low inflation and lower interest rates. Evidente remains of the view that the RBA will deliver more monetary stimulus at the November Board meeting on Melbourne Cup Day. (VIEW LINK)
Patrick Poke
You're right that the increased capital requirements don't affect the income statement, but that's not what's driving the decrease in value. If you value on an earnings per share basis, then increased capital requirements mean more shares have been issued without a corresponding increase in earnings, lowering earnings per share. Alternatively, if you're looking at ROE, it increases the equity, without a corresponding increase in returns, lowering ROE. I enjoyed the read nonetheless, it's always good to hear a different view on popular issues.
Sam Ferraro
Hi Patrick, thanks for reaching out with the feedback. With respect to the ROE, if the lift in equity is associated with a reduction in ROE, then it is because the company is less risky. This is consistent with the MM proposition that a lift in equity capital reduces the expected cost of equity. From a Gordon growth perspective, its not clear that this changes the book multiple. Although the expected roe falls, so does the discount rate, k, which should offset one another. p/e = 1/(k-g). p/bvps = roe/(k-g).