November 2015

Is a bank a business or a utility?
Earlier this year, ANZ group chairman David Gonski pleaded with the public to “stop bashing the banks” for being too big and too profitable.

Spurred by the media, bank bashing is one of the most popular national pastimes in Australia alongside cricket or the beach. This is despite the Big Four banks’ priority to reinforce stability and transparency.

Complete self-sufficiency and the ability to absorb a ‘black swan’ economic event is the goal, effectively relieving the government of ‘lender of last resort’ status and a repeat of tax payer funded bailouts witnessed in other countries during the Global Financial Crisis (GFC).

Adding to the public’s exasperation, banks have recently hiked variable mortgage interest rates citing the need to satisfy higher capital adequacy requirements. The contention revolves around the premise that bank profits are deemed exorbitant and yet they are still increasing fees.

The million dollar question remains – what is the basis for the public’s emphasis on, and criticism of, bank profits? Has the community at large shifted its perception of banks from a profit-making business to a utility or public service, thus expecting it to operate within those boundaries?

Consequently, the public relations battle will only become more tedious with each reporting cycle. With persistent negativity, both retail and business customers will devote additional thought to switching to alternative providers – most of whom are happy to provide the same products, with dedicated service and at a competitive price point.

Further, why do the likes of Apple return large profits but are left unscathed? How do Australia’s largest banks stack up against global brands that are able to avoid the ‘excessive profitability’ limelight?

First of all, comparing headline profit figures in dollar terms is misleading.

Return on Invested Capital (ROIC) is an ideal approach to ‘levelling the playing field’ given it represents how well a company is putting its capital to work. This is the profit returned for every dollar that is invested in the organisation, expressed as a percentage. ROIC also rules out foreign exchange fluctuations for companies reporting in US dollar terms.

Viewed on this basis, Australian banks don’t perform as strongly as companies in other industries. Rarely do we see articles in the media castigating Apple, in fact quite the opposite. Analysts are often praising the innovative wherewithal of the Silicon Valley based technology company, and devout customers line up and down the street whenever a new product is launched, despite the price tag.

Apple’s ROIC is a healthy 34.0 percent - almost seven times that of the Big Four banks - but no outrage to be seen here in the wake of the company’s own scandals or PR issues, just an enormous number of iPhones purchased year after year.
  Sportswear maker Nike, whilst not achieving as stellar a performance as Apple with a ROIC of 25.4 percent, also outperforms Australian banks substantially in this metric

Nike has withstood its own share of bad press in the past, yet customers are still clambering to get the latest Air Jordan’s to drive annual sales growth consistently above 8 percent and revenue higher year-on-year. Nike CEO Mark Parker has committed to exceeding revenue of US$50 billion within the next five years – an ambitious target well above current revenue of US$20 billion.

Closer to home, Harvey Norman exceeds all of the Big Four banks by a considerable margin yet no one is astonished that they are providing stronger profit advice against a raft of offshore and online competitors.

In fact, you hear more about Gerry Harvey being the victim of internet sales in the media than about how much money is being made by the group’s retail brands.

Even with all-time low interest rates, you can almost get as good a return on your investment as NAB achieved this year at a ROIC of 2.93 percent.

Shareholders are increasingly making their voice heard and expressing their view on how the banks are being run, demanding better returns despite the ‘lower for longer’ mentality brought on by regulators push for safer, stronger banks.

Let’s not forget either, most Australians’ Super holds a high proportion of bank shares. In the transition to more stringently regulated, safer banks it certainly appears the days of the ‘special dividend’ are long gone.

In a way the banks are not dissimilar to the Australian government’s current balancing act, pitting the need to stimulate greater economic growth, demand and infrastructure development against ‘budget repair’.

It is by no means an easy feat for the banks to continue upgrading their digital offering while socking vast sums of capital away to satisfy upcoming Basel IV requirements.

As analysts and investors closely examine EPS and dividend yield forecasts of the banking sector in the short and medium term in light of major headwinds, the banks are forced to adapt to maintain profitability and keep pace with the ever expanding array of new competitors.

Bank bashing may have effectively become ingrained in the Australian subconscious however the shift to strength and stability and popular view that A$30 billion in cumulative Big Four profits may be a peak could be the first sign of a shift in thinking.

The bank’s need only look at the corporations in other industries driving profits higher and winning the PR battle for inspiration.

As evidenced by the share economy and industries undergoing disruption, developing positive customer advocacy is the first battle to be won in a long and difficult war.
Return on Invested Capital

Source: 2014/15 company annual reports
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