ANZ meets expectations while Wesfarmers slightly disappoints in Australia

ANZ’s earnings and dividends are slightly ahead of our expectations and broadly in line with what the market was expecting. Cash earnings at slightly over $6bn shows that despite all the global challenges this year, the well oiled banking machine under CEO Mike Smith has managed to successfully navigate its way around all the turbulence. It’s not a perfect result – margins are under pressure, provisioning for bad debts is not as low as it should be and the rate of growth offshore has slowed slightly from the first half – but these are all shortcomings the market is willing to forgive.

Looking under the bonnet, loan and deposit growth on aggregate looks very solid, particularly in Australia where much of the conversation has been around volume growth pressures. In terms of margins, they have also been under pressure but the extent of decline is not worrying. The most important part for ANZ is funding and today’s data show not only has it successfully completed all its 2012 wholesale requirements, it is well advanced into 2013. Around 60% of total funding is still consumer driven, with solid growth across the board including again Australia. This might change slightly in 2013 as wholesale markets become more attractive and funding pressures reduce.

Arrears are improving, 90 loans for example are down 9% compared to March and down 7% compared to the same period last year. These will only improve as the RBA continues cutting rates. Bad loans below $1m are down 6% but there is a slight issue with large exposures, with bad loans in excess of $100m seeing a steep rise in exposure. This is more than accommodated by the level of provisioning. The key takeout is that the key residential mortgage book in Australia is showing no signs of systemic strains at all.

ANZ has its Asian growth strategy right about where it wants. We think it has taken the foot off the pedal over the past few months after a solid first half because it either wants to slightly de-risk its book or it prefers to grow a key acquisition. The region now generates around 21% of group revenue and this will only rise over the next five years. This is what makes ANZ such an attractive investment – it has a solid core Australian banking franchise and now a track record of successful growth in the world’s most attractive banking region. The shareprice is likely to be supported until dividends are paid, another round of bad news around Europe or jitters in the US after the election will provide a sell-off for banking stocks which we think will be around the best time to start buying back into ANZ. Our preference is to buy around $22-23 per share.

Coles surprises, the rest disappoint

Wesfarmer’s first quarter supermarket sales numbers for Coles look very solid on face value. The initial impression is to jump for joy, but we are quickly disappointed with the numbers elsewhere. More on that soon. Comparable food and liquor sales are 3.7% higher and this isn’t exactly off a weak prior corresponding period. Last year was already a very good number. The growth also came despite deflation of 3.2% so this implies some very strong volume growth numbers. Any gains made by Woolworth’s over its rival in the prior quarter seem to have now worked they way back. Either that or the RBA’s most recent rate cuts are starting to really hit home and improve the rate of retail spending.

The rest of the retail businesses posted mixed results – Bunnings grew comparable sales by 2.5%, Kmart’s comparables firmed 2.2%, Target saw more declines with comparable sales down a whopping 4.1% and Office Supplies was basically flat. The problem for Wesfarmers is that these other businesses matter too – the earnings decline in Target has been a major drag and often offsets earnings gains in food and liquor. The results here somewhat detract from the overall solid Coles headline rate. Our joy is short-lived.

It’s a mixed bag in our view particularly given the way Wesfarmer’s shares have risen over the past few months. We like the effort in Coles but think the turnaround in Target is taking too long. Coal prices are diving but this is largely expected, with Wesfarmers today announcing a 26% dip in pricing out of Curragh for the December quarter. We think the shareprice will struggle to maintain a rally above $35 per share until the other pieces of the pie fall into place.

The big test now comes for Woolworths who needs to show that its exit out of Dick Smith and focus back on supermarkets is starting to pay dividends. For that, it needs to at least match the comparable sales growth numbers booked by Coles and that will be a very big task – one that isn’t impossible. The jury is still out on its Home Improvement segment, perhaps its making a dent on Bunnings numbers, or the market is just maturing which won’t be good news.