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Behind the numbers – what’s in a profit?

ANZ, like all listed companies distributes financial data along with half and full-year results. But what is the market looking for?

Public companies announce detailed results at least twice a year, times when investors are inundated with profit and loss statements, balance sheets and performance metrics.

"The market looks at key drivers – did the company get there by revenue growth, cost reduction, bad debt charge changes?"
John Nguyen, Global Head of External & Regulatory Reporting

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For the investment market, there are some key questions: whether a company’s performance matched their expectations, how did the company present the numbers (and speaks to them) and what do emerging trends mean for future performance.

Brokers, analysts, fund managers and other market commentators will all have some expectations coming into a result as to where the numbers will land relative to the company’s previous performance but also relative to peers. 

The headline numbers as well as the composition of the results will be carefully mulled over to make a judgement as to the quality of the result – how did the company arrive at the headline profit, what contributed strongly to it, what detracted etc. 

So in particular in what is known as the Results Announcement pack, in ANZ’s case a book of around 150 pages, there’s quite a bit of background provided as to the drivers of the numbers delivered. 

Typically a chief executive and chief financial officer present the result to the market on the morning of its release, answering questions from both financial market representatives and journalists. Typically on day one questions will be focused at group level and looking at key themes – productivity, capital, costs and relative divisional contribution. 

For a bank like ANZ, there are a few key metrics that get zeroed in on early like cost to income, margins, return on equity (ROE), earnings per share (EPS) and Core Equity Tier 1 (CET1) ratio. 

ANZ presents both a Statutory Profit and Cash Profit. Cash profit is a measure used by Australian banks to demonstrate the strength of ongoing operations. It is calculated by removing from statutory profit the 'noise' of non-business-as-usual items such as revenue hedges, treasury shares and gains/losses from any sales or acquisition. Cash profit is a useful tool to allow the market to benchmark the 'true' underlying performance.  

The market then looks at the key drivers of the net profit after tax (NPAT) outcome – did the company get there by revenue growth, cost reduction, bad debt charge changes?

Usually there’s more interest in the pre-provision line - simply revenue less costs - as this talks more to how the business is tracking. Obviously for ANZ, both the geographic split of its profit and the relative rates of growth are important. Strong home markets in Australia and New Zealand are important as of course is evidence the company’s Super Regional Strategy is producing growth in Asia Pacific. 

Given ANZ operates in more than 30 countries, another measure that is important to assist in understanding the underlying performance of a multi-national company like this is foreign exchange-adjusted profit. This is a measure that strips out the effect of exchange rate movements on the company’s performance.  

Within revenue, net interest income and group net interest margin or NIM are closely scrutinised as the NIM is the difference between how much ANZ charges a borrower and how much it pays for the funds it lends. Net interest income represented around 70 per cent of total group revenue at the half hence the focus on it. 

With the exception of a tick up in the early stages of the financial crisis, the banking sector has seen a gradual decline in margin, largely driven by competition for both loans and deposits and lower returns on an ever larger amount of group capital in a low interest rate environment. Generally speaking, higher margins are good for a bank. The market will also look to determine if there has been a risk trade off to achieve the margin outcome (e.g. higher growth in riskier asset classes). 

Another revenue item that is increasingly of interest to investors is Other Operating income (OOI), which represented approximately 11 per cent to 12 per cent of ANZ’s revenue at the half. OOI is largely comprised of income generated from markets-related activities and is subject to some volatility. 

The provisions charge or bad debt charge, as the commentators tend to call it, is an accounting measure that effectively represents money set aside to cover the risk of loans that could have defaulted (as opposed to the regulatory requirement that measures the risk of loans defaulting in the future). As well as the absolute total dollars the market will also look at the proportion that’s in collective provisions versus individual provisions. 

Provision charges have been trending lower since the highs of 2008 and given that trend, the market is looking to determine if there are any signs of that improving trend ceasing and emerging signs of stress coming through. 

The balance sheet will be analysed to see if lending and deposits have grown faster or slower than system. Within that the market looks at what parts of the business have contributed and to what extent that is reflected in the profitability. The loan to deposit ratio will also be considered. 

Return on equity (ROE) is probably the single most important metric as it measures how well ANZ is using shareholders’ funds. Generally speaking, higher ROE means a company is able to generate more money for the same dollar amount spent.

Primarily investors will compare within a sector but also when structuring their portfolios, will balance higher and lower ROE sectors. Australian banks have ROEs at present between around 15 per cent to as high as 18.5 per cent which is quite a bit higher than most global peers. 

This then brings us to the cost to income (CTI) ratio. CTI impacts the 'R' or the return element in ROE as it reflects how efficiently you’re able to earn your income. You’ll hear people in the market talk about 'jaws', which represents the difference between the rate your income is growing and the rate your costs are growing. 

The market will be interested to see how banks are managing their capital and will look at the CET1 ratio and also the Internationally Harmonised Tier 1 ratio which are industry standards.

The key here is really comparability to peers and over the past few years each of the Australian major banks has grown capital to within a range of 8 per cent to 9 per cent. There’s quite a bit of focus about capital at the moment due to the Financial Services Inquiry and so this number will be carefully scrutinised in upcoming reports. 

Last but not least there is a focus on dividends (dividend per share or DPS) or more particularly what’s called dividend payout ratio – the proportion of a company’s profit paid out to shareholders. In addition, earnings per share or EPS, which speaks to increasing performance for shareholders, is a key measure of interest to the market. The market will look carefully as to whether DPS and EPS are aligned – usually there will be a correlation between the two. 

For a shareholder, this is what counts: what is an investment earning and what is the relative cost of that earning potential.

John Nguyen is ANZ's Global Head of External and Regulatory Reporting. Responsible for reporting ANZ's half year and year end results, as well as regulatory reporting to APRA.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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