Company Reports

No-moat Bendigo and Adelaide Bank’s AUD 562 million fiscal 2024 cash profit came in 2% above our forecast, with lower-than-expected bad debt expenses partly offset by higher operating expenses. Efficiency measures—including moving to one core banking system and consolidating brands—should eliminate cost duplication, but we think these take time to feed through to earnings. We forecast a gradual improvement in Bendigo’s cost/income ratio over the next five years, to 56% by fiscal 2029, roughly 200 basis points below fiscal 2024. Our long-term outlook is intact, and our fair value estimate lifts 3% to AUD 10.80 per share, mostly due to the time value of money. Shares in Bendigo screen as modestly overvalued.

Bendigo and Adelaide Bank is one of Australia’s top 10 largest banks, but by loans and deposits is much smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank have helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

On a weighted average basis, major bank share prices increased 28% in the 12 months to June 30, 2024, outperforming the 8% increase in the Morningstar Australia Index. It is hard to pinpoint a single specific driver for the turnaround in bank sentiment. On the earnings front, signs of repricing loans and deposits to protect margins and low loan losses, are positives. But global funds increasing ownership and inflows into passive funds has likely also supported prices.

Being much smaller than the major banks, reducing complexity and driving efficiency with digitization is crucial for no-moat Bendigo and Adelaide Bank to compete. The bank’s investor day highlighted recent success and work in progress on simplification and digitization, as well as growth opportunities. The bank is moving to one core banking system and consolidating brands, which should eliminate cost duplication and is in the early stages of rolling out a new loan origination platform, which should lower the cost of writing loans.

Bendigo and Adelaide Bank is one of Australia’s top 10 largest banks, but by loans and deposits is much smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank have helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

Following a better-than-expected trading update from Bendigo and Adelaide Bank, we lift our fiscal 2024 forecast for cash earnings aftertax by 12% to AUD 558 million. This would equate to a decline of just 3% from fiscal 2023. For the 10 months ending April 30, 2024, Bendigo and Adelaide Bank’s cash earnings aftertax were approximately AUD 464 million, down 2.3% year on year. Despite competition for lending and deposits, net interest margin was resilient at 1.87% year to date, up from 1.83% at the end of December. Credit expenses also remained low during the period, which helped earnings.

After reasonably uneventful earnings updates, it is hard to pinpoint a single specific driver for the turnaround in bank sentiment. Still, we think part of it is that a likely lower cash rate eases housing fears and provides banks an opportunity to reprice loans and deposits to protect margins. Major bank share prices increased 23% since November 2023, outperforming the 16% increase in the Morningstar Australia Index over the same period. The major banks' weighted average price/fair value estimate is 1.14, up from 1.05 in the last quarter. Nonmajor banks trade at a price/fair value of 0.85.

Margins are under pressure, loan balances are treading water, and operating expenses are rising. But Bendigo and Adelaide Bank is expected to benefit from less intense competitive pricing and an improved digital offering over the medium term. In addition to the bank’s digital offerings attracting new customers, we are confident successful digital loan and deposit products can be leveraged across the bank, especially in its mortgage broker channel. The bank is well-capitalized and heavily deposit-funded, and credit quality is sound.

Bendigo and Adelaide Bank is one of Australia’s top 10 largest banks, but by loans and deposits is much smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank have helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

Australian banks face low credit growth, softer net interest margins, and an increase in loan losses in the short term. Industry returns on equity will be suppressed in fiscal 2024. However, we expect loan and deposit pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate maintainable returns above our 9% cost of equity.

The short-term outlook for Australian banks is challenging with margins under pressure, loan losses expected to rise, and inflationary cost pressures unable to be offset by cost-cutting initiatives. Industry returns on equity are suppressed, hence we expect loan and deposit-pricing changes in the medium term to lift margins to a level that allows wide-moat-rated major banks to generate returns above our 9% cost of equity.

Bendigo and Adelaide Bank reported a solid first-half fiscal 2023, with cash profit of AUD 295 million up 13% on last year. The increase on second-half fiscal 2022, up 23%, highlights the magnitude of the earnings rebound as the bank benefits in a higher cash rate environment. Net interest margin, or NIM, increased 19 basis points to 1.88% over the half, driving profit before bad debts up 29%.

The increases in the Reserve Bank of Australia cash rate to arrest inflation will have an impact on key earnings drivers for the banks. With the cash rate currently at 2.35%, and likely north of 3% by year-end, the increases from just 0.1% in April 2022 have been swift. It is expected to slow credit growth, with less borrowing capacity and confidence (a complete turnaround from the fear-of-missing-out environment of recent years). However, we think bank sector revenue growth will be buoyed by higher net interest margins, with the spread between lending rates and the cost of customer deposits widening.

Environmental, social and governance, or ESG, factors can have a material bearing on the cash flow and valuation of firms. In the past, issues such as James Hardie’s asbestos liability or AMP’s management of its conflicts of interest have had a material impact on the valuation of those firms. Identifying and assessing ESG risks is critical to any thorough assessment of a company’s cash flow and earnings potential. At Morningstar, we incorporate ESG into our long-term-oriented methodology by focusing on issues with the highest risk, defined by likelihood and materiality to a company’s intrinsic value.

What a difference six months can make. Bendigo and Adelaide Bank’s AUD 244 million first-half profit was up 156% on second-half fiscal 2020. The result was better than we expected overall. The extremely low loan losses, which can be volatile in uncertain periods, is the key driver behind a 39% increase in our fiscal 2021 profit forecast. Bad and doubtful debts of AUD 19.5 million compare with AUD 145.3 million (predominantly COVID-19 provisions) in second-half fiscal 2020. We expect higher losses in the second half of fiscal 2021 as loan deferrals and government support packages end, despite the provisions taken in 2020 curbing the impact on earnings.

Bendigo and Adelaide Bank is Australia’s fifth-largest bank, but is roughly 10 times smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank (previously the Bank of Cyprus Australia) has helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

Bendigo and Adelaide Bank is Australia’s fifth-largest bank, but is roughly 10 times smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank (previously the Bank of Cyprus Australia) has helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

We have increased our fiscal 2021 dividend forecasts across our banking coverage following APRA’s announcement that from 2021, the regulator will no longer require banks to limit distributions to 50% of earnings. We had assumed the restriction would be in place until fiscal 2022, but the improvement in the economic outlook, sharp decline in temporarily deferred loans, and the banks’ capital positions, provide us comfort the move is not too early. The increase to dividends is not material to our fair value estimates. We continue to see Westpac as modestly undervalued, ANZ and National Australia Bank fairly valued, and Commonwealth Bank overvalued. On our updated numbers, the banks trade on fully franked fiscal 2021 dividend yields of 3.5% to 4.5%.

Bendigo and Adelaide Bank is Australia’s fifth-largest bank, but is roughly 10 times smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank (previously the Bank of Cyprus Australia) has helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

After reviewing our outlook for Bendigo and Adelaide Bank, or Bendigo, we have made modest adjustments to longer-term operating cost and loan loss expectations which increase our fair value estimate by 3% to AUD 9.00. Bendigo’s multichannel distribution strategy, with community and corporate branches, mobile lenders, white-label loans for mortgage brokers, and online lender Tic:Toc, has seen the bank impressively grow market share in a competitive environment. But, to sustainably grow earnings per share and lift returns on shareholders' equity, the bank must become more efficient. In the five-years to June 30, 2020, net loans increased 17%, net interest income increased 14.5%, and operating expenses increased 19%.