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Westpac Banking Corp (ASX: WBC) shares experienced a notable decline on Thursday, ending the day nearly 1% lower at AU$26.87. This drop follows a downgrade from analysts at Goldman Sachs, who have raised concerns about the current valuation of Australian banks.
Reasons Behind the Decline
The key driver behind the sell-off was a critical note from Goldman Sachs, which suggests that bank valuations are currently "at extremes." The broker's review highlights several metrics that underpin this assessment:
- Valuation Extremes: Goldman Sachs pointed out that Australian bank valuations are at their highest levels, with 12-month forward Price-to-Earnings Ratios (PERs) reaching the 99th percentile. The broker's discounted cash flow (DCF) valuations are, on average, 175% below current share prices.
- Yield Spread Concerns: The spread between fully-franked yields of banks and the 10-year bond yield is at its lowest in nearly 15 years, further indicating potential overvaluation.
Comparative Valuation Analysis
While Goldman Sachs acknowledges that, compared to industrials, banks may not seem overly expensive, they caution against relying solely on this metric. The note elaborates:
- PER Comparison with Non-Bank Industrials: Although banks have re-rated significantly over the past year and continue to trade nearly 5% below their long-term historical averages against non-bank industrials, this approach might be simplistic.
- Fundamental Evolution: The broker stresses that relative fundamentals between banks and non-bank industrials have evolved. Despite the recent reporting season indicating a slowdown in the pace of deterioration in bank fundamentals, a significant improvement is not anticipated.
Limited Upside Potential
Goldman Sachs concludes that the deterioration in bank earnings may have stabilised, but there is limited upside potential from current levels. The broker's analysis indicates that the risks are skewed to the downside, making a negative view on the banks more appropriate at this juncture.
Downgrade and Price Target
Given these concerns, Goldman Sachs has downgraded Westpac shares from a neutral to a sell rating, maintaining a price target of $24.10. This represents a potential downside of over 10% from the current share price of $26.87, indicating that investors might face further losses over the next 12 months.
Implications for Investors
The downgrade by Goldman Sachs sends a strong signal to investors about the potential overvaluation in the banking sector, particularly for Westpac. With the broker highlighting limited improvement in fundamentals and asymmetric downside risks, the recommendation to sell reflects a cautious stance on the bank's future performance.
