EWA - EWA: Don't Want The Banks

2024-01-10 17:20:12 ET

Summary

• iShares MSCI Australia ETF is rather above average in terms of expense ratios.
• Moreover, markets seem to broadly apply steep multiples to non-mining exposures in Australia, particularly financials.
• Since mining is what interests us in this ETF, we forego taking on what we think are too expensive exposures in non-mining sectors in Australia in favor of select picks.
• We don't feel the EWA ETF is competitive with resident fixed rate investments.

The iShares MSCI Australia ETF ( EWA ) holds a representative swath of the Australian market on a value-weighted basis. Financials and mining feature heavily consistent with Australia's overall economic profile. While we have no major issue with mining, and in fact have our preferred pick Perenti Limited ( AUSDF ), or any issue with the AUD, we don't want the financial exposures at their current valuations which cap the value angle. We pass on EWA in favor of more select picks in the Australian market.

EWA Breakdown

Due to the scale and capital requirements of miners, and also due to the outsized presence of mining in the Australian GDP mix of around 10%, they have a pretty prominent place on the markets and in EWA at 25%.

Financials are even bigger at 33%, so those two sectors will be of focus.

Expense ratios are pretty high for EWA at 0.5%. While some frictions can be expected for a foreign market, this approaches expense ratios for pretty exotic ETFs, like that of the Thai market among others, and is a disappointment considering Australian markets and the AUD are all quite liquid. APAC equity ETFs usually have lower expense ratios, averaging around 0.3% according to FactSet.

Bottom Line

Let's focus on the mining exposures. Mining should have an average P/E around 8x . The EWA has a P/E around 16x. This implies an average 18.6x P/E for the non-materials exposures in EWA, which is rather high considering it is lacking IT weighting, and this mainly being driven by financials.

The situation for financials is as follows according to our read on the Australian market. The first thing to note about Australia is that they have an exceptionally expensive property market and big mortgage market. A lot of these mortgages are fixed rate, around 40% according to peaks in 2022, also resulting in inflation remaining pretty high despite Australia following, although to a lesser extent, in the global rate hiking regime. Their rates have gone from around 0% like everywhere else to a 4.25% rate , which is not that far off the U.S. Inflation is still above the 4% mark, as the transmission from rates is mitigated by fixed rate mortgages.

The market for lenders in Australia is not unhealthy, and the shortage of real estate means values continue to climb and so do loans. The higher rates also allows for better returns on lent money, but there is also deposit beta to contend with, as Australia will likely do a higher for longer regime to deal with that inflation. Further rate hikes seem unlikely, though, due to the fact that the nation is still leveraged, and Australia has already indicated that it is worried about putting undue pressures. This all at least supports the AUD, which has only come up around 5% from lows a couple of months ago compared to the USD, and could go more, but it's not that great for financials.

In all, an 19x P/E for the exposures that are not mining seems pretty high to us, considering it offers barely more than a 5% earnings yield and resident interest rates are at 4.25%. Considering there isn't much reason to expect exceptional growth, we don't see the benefits here with iShares MSCI Australia ETF and would rather take individual picks, especially in mining where P.Es are quite low, than lose 0.5% annually for the expense ratio without a great value angle.

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