Will the Regulatory Initiatives Future-proof the Resilience of the Financial Services System – 3 Stocks to Consider

I. Sector Landscape and Outlook

As per the Reserve Bank of New Zealand (RBNZ), the global financial conditions have tightened as central banks around the globe responded promptly to the high consumer price inflation and increasing inflation expectations driven by elevated geopolitical tensions. New Zealand house prices have fallen modestly but remain at an elevated level. The disruptions due to COVID-19 and geopolitical tensions have created challenges for New Zealand’s businesses, thereby impacting growth momentum.

Exhibit 1: Asset Prices, Households, and Businesses Performance

Total Funds Under Management Fallen Quarterly while Up Annually

As per RBNZ, the total funds under management fell 2.6% QoQ to $257.3 billion for the quarter ended 31st March 2022, while reporting an annual increase of 8.2%. The fall in total funds under management is likely led by multiple factors like rising interest rates and inflation. Kiwisaver and Other Superannuation schemes decreased 2.5% this quarter to $92.3 billion while reporting a 10.8% rise from Q1 2021. Meanwhile, total industry holdings of listed shares fell 5.9% from $131 billion to $123.2 billion, while long-term debt securities stayed flat again this quarter, falling 1.5% to $63.2b from $64.2b last quarter. Cash holdings have increased 3.0%, from $33.9 billion to $35 billion. Further, private Wealth fell 4.5% this quarter from $41.4 billion to $39.6 billion.

Exhibit 2: Trend in Managed Funds: Assets by Sector in NZ ($bn)

Data Source: This work is based on/includes rbnz data which are licensed by rbnz.govt.nz for reuse under the Creative Commons Attribution 4.0 International Licence; Chart Analysis by Kalkine Group

Positive Momentum Continues in Business Lending

RBNZ's total housing lending stock grew by $1.1 billion (0.3%) in June 2022, down on the $1.2 billion (0.4%) rise reported in May 2022. However, the annual growth decreased to 6.9%, sliding further from 7.4% in May 2022. Additionally, the total personal consumer lending stock fell by $29 million (-0.2%) in June 2022, while the annual growth increased to -6.1% from -6.6% in May 2022. Meanwhile, the total business lending stock grew by $1.0 billion (0.8%) in June 2022, while its annual growth fell from 8.9% to 8.6%. The total agriculture lending stock grew by $310 million (0.5%) in June 2022, and yearly growth increased from -1.0% to -0.6%.

Exhibit 3: Lending Pattern Since March 2020 – Banks and NBLIs

Data Source: This work is based on/includes rbnz data which are licensed by rbnz.govt.nz for reuse under the Creative Commons Attribution 4.0 International Licence; Chart Created by Kalkine Group

Financial Institutions’ Resilience Has Remained Solid

As per RBNZ, registered banks’ capital buffers remained high, and all banks are above minimum prudential requirements indicating effective capital implementation. Further, the registered banks have sound liquidity positions to meet customer withdrawals. The funding ratio requirement has returned to 75% from 50% since January 2022. The condition of bank funding has been solid over the last two years, partly because of monetary policy measures like the Large Scale Asset Purchase (LSAP) Programme and the Funding for Lending Programme (FLP), which have limited interest rates and increased liquid assets in the banking system.

Index Performance:

The S&P/NZX All Financials Index generated a 5-year return of ~51.50% versus ~4.22% by the S&P/NZX 50 Index. Therefore, S&P/NZX All Financials Index overperformed S&P/NZX 50 Index by ~47.28% in 5-year.

Exhibit 4: S&P/NZX All Financials Index vs S&P/NZX 50 Index

Source: REFINITIV

Key Risks and Challenges:

Financial market participants are adjusting to increased uncertainty caused by changes in monetary policies and the challenging geopolitical environment. Major equity indices have declined from their highs as rising interest rates limited future earnings' discounted value and dampened the growth outlook. Risk premiums increased momentarily, and risk spreads widened in wholesale credit markets.

Exhibit 5. Key Risks in Financial Services Sector:

Source: Analysis by Kalkine Group

Outlook:

The economic growth prospect is softened due to continued pressure on the central banks to maintain low and stable inflation and avoid unnecessary volatility in financial conditions. NZ inflation increased to a multi-decade high of 7.3% in the June 2022 quarter. Meanwhile, RBNZ raised its policy rate to 2.5% and expected further tightening. On the positive side, the export values increased 6.9% in the June 2022 quarter, driven by the rise in 9 of 10 categories due to higher prices and increased volumes. Despite a narrower trade deficit in the June 2022 quarter, the annual deficit grew by almost NZ$1 billion to a new high of $10.5 billion (about 3% of GDP). The export growth indicates positive momentum in the economy and financial sector. Meanwhile, financial institutions’ resilience remained robust in the last 6-month despite rising interest rates, geopolitical risks, and COVID-19. The banks’ profitability recovered to pre-2020 levels, and insurers have retained high capital levels.

Apart from the sector-specific factors, we have also analysed three NZX-listed companies operating in the same sector. This report covers their insights, outlook, performance and potential as expected to be delivered in the near to medium term.

1) Heartland Group Holdings Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$1.25 billion, Gross Dividend Yield (TTM¹): 8.23%)

Business Description:

Heartland Group Holdings Limited (NZX: HGH) is a financial services group. In New Zealand, Heartland Bank Limited is a registered bank. The company provides reverse mortgage loans and funding to small business and customer lending sectors through Australian businesses.

Outlook:

The company surpassed its NPAT expectations in H1FY22. However, expects growth in 2HFY22 to slow for Motor and online Home Loans due to CCCFA impact. The company anticipates the continued shift in portfolio mix toward higher quality and lower risk assets is likely to impact NIM in 2H2022. These challenges would be offset by sustained improvement in operational efficiency and asset quality. Heartland expects NPAT for FY22 to be within the guidance range of $93 million to $96 million.

Valuation Methodology: Price/Book Value Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation:

The stock has been valued using P/B value per share based relative valuation (on an illustrative basis), and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to P/B value per share multiple (NTM) (Peer Average), considering the decent outlook as well as

increased profitability and its strategic priorities towards expansion in Australia through potential acquisitions.

Considering the aforementioned factors, a ‘Buy’ recommendation has been given on the stock at the closing market price of $2.11 per share as of 4 August 2022.

2) NZX Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$378.90 million, Gross Dividend Yield (TTM¹): 7.00%)

Business Description:

NZX Limited (NZX: NZX) is a listed stock exchange in New Zealand. It is engaged in providing an array of quality financial services to its customers both domestic as well as global.

Outlook:

The company expects to undertake further investment in 2022 to support additional capacity, capability, and to enhance the security of its operating platform. Further, due to increased market volatility and tighter financial conditions, the board conservatively expects operating earnings for FY22 to remain between NZD33.5 million to NZD38.0 million.

Valuation Methodology: Price/Book Value Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation:

The stock has been valued using P/B value per share based on relative valuation (on an illustrative basis), and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to the P/B value per share multiple (NTM) (Peer Average), considering its healthy operating earnings in FY21 that surpassed guidance and strategic growth initiatives.

Considering the aforementioned factors, a ‘Buy’ recommendation has been given on the stock at the closing market price of $1.21 per share, up by ~0.83% as of 4 August 2022.

3) Australia and New Zealand Banking Group Limited (Recommendation: Hold, Potential Upside: Low Double-Digit) (M-Cap: NZ$72.84 billion, Gross Dividend Yield (TTM¹): 8.88%)

Business Description:

Australia and New Zealand Banking Group Limited (NZX: ANZ) is Australia’s 3^rd largest banking and financial services group, with operations extending across Australia and offshore in NZ, East Asia, and the Pacific Islands.

Outlook

The bank is seeing solid demand from business customers and is well placed to support them when inflation and interest rates are alarming. Further, it expects a complex economic environment going ahead but will continue to make necessary changes to absorb risks, business settings and investment opportunities as required

On 28 July 2022, the company announced that it completed the dispatch of the Retail Information Booklet and personalised Entitlement and Acceptance Forms to retail shareholders.

Valuation Methodology: Price/Book Value Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation:

The stock has been valued using P/B value per share based on relative valuation (on an illustrative basis), and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to the P/B value per share multiple (NTM) (Peer Average), considering a combination of strong capital management, solid earnings, and current investments in future growth opportunities.

Considering the aforementioned factors, a ‘Hold’ recommendation has been given on the stock at the closing market price of $25.18 per share, down by ~0.28% as of 4 August 2022.

Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.

Note 1: Past performance is not a reliable indicator of future performance.

Note 2: The reference date for all price data, currency, technical indicators, support, and resistance levels is July 28, 2022. The reference data in this report has been partly sourced from REFINITIV.

Note 3: Investment decisions should be made depending on an individual's appetite for upside potential, risks, holding duration, and any previous holdings. An 'Exit' from the stock can be considered if the Target Price mentioned as per the Valuation and or the technical levels provided has been achieved and is subject to the factors discussed above.

Note 4:  Annual Dividend Yield is on a Trailing Twelve Month (TTM¹) basis and are subject to change based on factors such as company performance, stock price changes, etc.

Technical Indicators Defined: -

Support: A level at which the stock prices tend to find support if they are falling, and a downtrend may take a pause backed by demand or buying interest. Support 1 refers to the nearby support level for the stock and if the price breaches the level, then Support 2 may act as the crucial support level for the stock.

Resistance: A level at which the stock prices tend to find resistance when they are rising, and an uptrend may take a pause due to profit booking or selling interest. Resistance 1 refers to the nearby resistance level for the stock and if the price surpasses the level, then Resistance 2 may act as the crucial resistance level for the stock.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

Disclaimer

Kalkine New Zealand Limited is authorised to provide general advice only. The information on this website does not take into account any of your investment objectives, financial situation or needs. Before you make a decision about whether to acquire a financial product, you should obtain the Product Disclosure Statement from the product issuer. You should consider the appropriateness of advice taking into account your own objectives, financial situation and needs and seek independent financial advice before making any financial decisions.