Martin Conlon, head of Australian equities at Schroders, has warned that sustainable bank profits are likely to be some 25 per cent below current levels when normalised bad debts and an educated guess at penalties are taken into account.
Writing the monthly report for the Schroder Equity Opportunities Fund, Mr Conlon said this would take bank earnings multiples from apparently very cheap current levels back to the mid to high teens.
Mr Conlon did however say this would still leave banks as “fairly attractively valued” and far more appealing than large segments of the equity market.
He singled out the comparison between Australia and New Zealand Banking Group Ltd (ASX:ANZ) and high-flying CSL Limited (ASX:CSL).
Despite both companies having similar market capitalisations, ANZ is expected to generate earnings of around $7 billion versus forecasts of around $2 billion for CSL.
Mr Conlon admitted CSL is a wonderful company, but as an already very large and profitable player in the plasma industry, its profits need to triple to match ANZ. Mr Conlon said he cannot bridge the valuation gap between the two companies.
CSL subsequently upgraded its profit guidance, saying it expects FY 18 profits to be around $2.25 billion.
At the end of April 2018, the Schroder Equity Opportunities Fund reported a zero per cent holding in CSL Limited and a 3.2 per cent holding in Commonwealth Bank of Australia (ASX:CBA).
Of the fund’s top 5 active positions, Fletcher Building Limited (ASX:FBU) was the largest, a 4.5 per cent holding.
Mr Conlon named Fletcher as one of a number of companies continuing the process of trying to repair the drawn out damage of woefully misguided acquisition strategies. Other companies undergoing similar repair operations were named as QBE Insurance Group Ltd (ASX:QBE), AMP Limited (ASX:AMP) and BHP Billiton Ltd (ASX:BHP).
Mr Conlon said the likes of Corporate Travel Management Ltd (ASX:CTD) and WiseTech Global Ltd (ASX:WTC) “continue to garner support for aggressive acquisition strategies that we believe will presage future disasters.”
Earlier this week, the WiseTech Global share price jumped higher after the logistics software company announced the issue of ~$100m in shares to a single global institutional investor.
Mr Conlon much prefers companies with successful organic growth strategies, naming Fortescue Metals Group Ltd (ASX:FMG), Cochlear Limited (ASX:COH) and Xero Ltd (ASX:XRO) as examples.
You can read the full monthly report by clicking here.
Over the past 5 years, the Schroder Equity Opportunities Fund has out-performed its benchmark, up 9.53 per cent per annum versus the S&P/ASX 300 Accumulation Index gain of 7.52 per cent per annum.