Australian economic growth has slowed down largely due to lower demand for resources that the country has in abundance. The Australian mining sector, the biggest contributor to the country's economy, is hurt considerably due to lower demand for iron ore from China and India, which makes us believe that the Australian economy is expected to slow down further. The lower demand of iron ore has resulted in a 30% decline in the prices over the past two months. The country's resources minister himself declared that the mining boom is over and that the industry has cut over 900 jobs. The mining slowdown, besides affecting the mining companies directly, is also affecting Australian banks indirectly. Despite the fact that the big-four Australian banks have less than 1% of their loan books exposed to mining sector lending, we believe as much as 9% of the banking profits can be adversely affected by the mining slowdown. We believe Australia and New Zealand Banking Group (OTCPK:ANZBY) and Westpac Banking Corporation (NYSE:WBK) would be most negatively affected if the mining slowdown deepens. The banks would also be affected due to the slowdown in the country's economy as a result of the mining slowdown. Therefore, we recommend that our investors short the stocks.
Australia and New Zealand Banking Group:
During the most recent scenario test conducted by the Commonwealth Bank (OTCPK:CBAUF), ANZ was considered to be most exposed to the country's mining sector. The bank's profit for the year 2013 will take up to a 9.3% hit if the slowdown in the Australian mining deepens. While in a worst case scenario, the bank's profits will contract by over 17%.
For the stock that has a current price of $25.7 per share, analysts have a mean price target of $26, while the bearish price target is $22.7 per share. two out of a total of 20 analysts rate the stock as underperform, while 7 analysts rate it as hold.
The stock, which has seen over 25% appreciation in price since the beginning of the year, trades at a 7% discount to its book value and has a P/E ratio of 12.51 times.
Westpac Banking Corporation:
The test conducted by the Commonwealth Bank revealed that Westpac stands just behind ANZ in taking a hit if the slowdown in Australian mining deepens. The bank's coming year's profits will contract by 8%. Westpac has been downgraded from neutral to sell by Goldman Sachs on expectations of weaker loan growth and lower margins, limiting the growth in share price in the foreseeable future.
For the stock that has a current price of $25.4 per share, analysts have a mean price target of $24.5, while the bearish price target is $21.5 per share. Currently, 12 out of 19 analysts have a hold rating for the stock, while 2 rate the stock as underperform.
The stock of Westpac, which has seen over 27% price appreciation since the beginning of the year, trades at an 80% premium to its book value and has a P/E ratio of 13.3 times.
In conclusion, we believe Australian banks will be adversely affected from the slowdown in the country's mining slowdown, which we believe would lead to an economic slowdown in Australia. Therefore, we recommend investors to short WBC and ANZ.