Shares in the leading Irish financial stocks have risen by substantially more than the broader market in 1998. Despite their strong price performance, stock-by-stock analysis suggests that these companies are still trading at undemanding multiples relative to their international peer groups.
We believe that a number of factors should help underpin further strong price performances into next year.
Firstly, Irish financials will continue to have significant appeal for those investors looking to gain exposure to Europe's fastest growing economy and financial services market in 1999.
Demographic factors and lower interest rates will continue to stimulate economic activity and we expect loan volume growth to run at close to 20 per cent in 1999, compared to a likely 24 to 25 per cent in 1998.
This level of growth will be at the very top of the euro zone range and will more than compensate for the loss of revenues and reduction in net interest margins associated with the introduction of the new currency. It should also help offset the increased competitive pressures likely to be experienced within the sector as a result of the merger of Irish Life and Irish Permanent.
Secondly, asset quality should continue to remain very high within the domestic operations of the banks, not least as a result of the relatively low level of interest rates set to prevail within the euro zone in and beyond 1999.
Any problems in this area are more likely to come from overseas operations, with some deterioration in performance being seen as almost inevitable from current levels. This applies particularly to Britain, where Bank of Ireland has the greatest relative exposure of the Irish financial stocks - through Bristol & West.
Thirdly, Government proposals to reduce the rate of corporation tax to 12.5 per cent by 2003 will provide an automatic boost to earnings for companies currently taxed at the full rate. The banking sector will benefit both directly and indirectly from the new regime - directly as its corporation tax burden is reduced and indirectly as its service customer base expands, given that these businesses in turn are primed to expand in response to lower tax rates.
The proposals to reduce the corporation tax rate to 12.5 per cent have been accepted by the EU. Given that these do not fall foul of the sole criterion for objection of "differential taxation" we regard the new regime as a done deal.
Pure Irish banks (and other pure Irish service sector plays) will see net income rise by a cumulative 29 per cent, or 5 per cent per annum, in the five years to 2003 for a given level of pre-tax income. Accordingly, we believe that the boost to earnings from corporation tax cuts should now be fully factored into valuations. Current prospective price/earnings ratios and price/book calculations suggest that this has not yet occurred.
Fourthly, Irish financials will offer attractions for those investors looking to play the consolidation theme in this sector within the new euro zone.
Finally, our view is that the strategic value of the Irish financial service companies should increase as a result of the new tax regime. In particular, processing power will become more valuable in its own right, independent of the value within a financial sector company's franchise.
Shane Nolan is a financial sector analyst with NCB Stockbrokers
