Overview Share market volatility peaked in the

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Overview: Share market volatility peaked in the Market Happenings Ben Guess
market around mid to late March coinciding with                                           The market continues to bounce across lows. Ben
the low point from which the Australian share                                             Guess revisits some of the recent share market events.
market made a recovery reaching 6060 points in                                            Page 2
late May before falling again on a wave of further
US credit and equity market nervousness. Several                                          The Economy and Markets: The Federal
US investment banks have been downgraded                                                  Budget: Darryl Gobbett
which is affecting the share prices of financial                                          The new Labor Government delivers it s first budget.
stocks across the world. The Australian financials                                        Darryl delivers his verdict. Page 5
have not been able to avoid the carnage and have
fallen despite not having the same exposures, they                                        Four Interims and a Merger - The Bank s
have been tarred with the same brush. There are                                           Reporting Season: Travis Adams.
some quality financials that look attractive for long                                     The bank s are in one of the more interesting periods of
term purchases although share price volatility is                                         the past 15 years. Interim reporting season gives us an
likely to continue. Quality financials are available                                      opportunity to judge their performance. Page 9
at cheap prices.
                                                                                          Financial & Economic Forecasts                                           Page 16




Important Disclosure PLEASE READ: The information contained within this document was compiled by Prescott Securities Limited (PSL) based on materials from other sources
and PSL provide no warranty regarding the accuracy or completeness of the information. All opinions, conclusions, forecasts or recommendations are reasonably held at the time of
compilation but are subject to change without notice by PSL. PSL assumes no obligation to update this document after it has been issued. Except for any liability which by law can-
not be excluded, PSL, its Directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information
contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information.
This publication is intended to provide background information only and does not purport to make any recommendation upon which you may reasonably rely without taking further
advice. This publication does not take into account any person's investment objectives, financial situation and particular needs. Should you consider the acquisition of a particular
financial product as a result of the material contained, you should obtain a copy of and consider the Product Disclosure Statement (where applicable) for that product before making
any decision. PSL may receive a fee for advice and/or the implementation of an investment decision. PSL and their representatives may have financial interests in some/any of the
product(s) included within this report. Prescott Securities Limited (PSL) is the holder of an Australian Financial Services Licensee No: 228894. PSL is a WHK Group firm.
                                                                                                        2

Market Happenings: Benjamin Guess
It has been a month dominated by concerns over the depth of credit problems in the US constraining our
market with the All Ordinaries down by around 5.6%. Investors are searching for a sign that confidence will
return and move stocks higher. Underlying company earnings are expected to continue to grow but at a slower
rate than over the past few years, a positive indication that share prices will again head north at some stage in
the future. Telling when that point may be is another story.
Macquarie Group (MQG) reported NPAT up 23% to $1.8bn for the year ended 31 March 2008. The result was
achieved after allowing for a $293m write-down of holdings in certain listed real estate investments. Despite the
more challenging credit market conditions, this is the 16th consecutive year of record profits. Revenues from
ordinary activities were $8.25Bn, up 15% from last year. Despite challenging market conditions, good corporate
finance deal flow combined with favourable equity and commodity business contributions were key drivers of
the overall growth in operating income. Diluted EPS was 653.5 cents compared to 569.8 cents last year. The
net operating cash outflow was $18.61Bn compared to an inflow of $975m in the pcp. The final dividend
declared was 200 cents fully franked, taking the full year dividend to 345 cents compared with 315 cents last
year.
Foster's Group (FGL) announced a revised fiscal 2008 earnings outlook, a non-cash write down to wine asset
carrying values and a strategic review of the global wine business. Foster's currently expects fiscal 2008 net
profit after tax before significant items and SGARA to be between $700m and $715m. Earnings per share
before significant items and SGARA is expected to be between 36.2 cents and 36.9 cents. The Company
expects solid second half EBITS growth in Foster's Australia, Asia and Pacific (AAP) region, however, volume
and net sales revenue growth has slowed. The Foster's Board has also accepted the resignation of CEO,
Trevor O'Hoy. Trevor has agreed to stay on to facilitate an orderly transition until the appointment of his
successor.
BHP Billiton Chief Executive Marius Kloppers said he believes the miner's takeover bid for rival Rio Tinto
(RIO) will be successful and the combined entity would achieve more than either company can on its own. "If
our takeover of Rio Tinto is successful - and I believe it will be - the combination will create even greater value
for shareholders," he said at the Melbourne Mining Club. In an upbeat speech, Kloppers said demand for
commodities is expected to continue to grow with China to remain the key driver and that BHP is well
positioned to benefit with annual production expected to grow by 7% over the next five years. Kloppers said a
planned expansion of the Olympic Dam copper, gold and uranium mine is a key growth project and said BHP is
currently planning several phases of expansion. He also highlighted the miner's petroleum division, which he
said is a core part of its business and is expected to post 10% annual growth in petroleum production to 2011.
Challenger Financial Services Group (CGF) announced it had reached agreement with AXA to transfer to




                                                         2


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                                                                                                       3

Challenger its $1.3bn Australian annuity portfolio. This annuity portfolio, which will be backed by approx
$1.25bn of assets, will bring Challenger's annuity, allocated pension and personal superannuation portfolio to
$5.1bn and will add some 17,000 new customers to Challenger's base. In a parallel transaction, Challenger will
sell its Financial Planning business (comprising Genesys Wealth Advisers and Synergy Capital Management)
to AXA for $150m in cash.
Metcash (MTS) reported a 25% increase in full-year net profit to $197.4m, from $158.6m a year before. The
result is in line with expectations. "We have built up good momentum and expect further profit growth in the
new financial year," chief executive Andrew Reitzer said in a statement. Metcash said May sales have
remained strong and in line with expectations. The company forecast earnings per share of 28.3 to 29.3 cents
per share for fiscal 2009, up from 26.64 cents a share in fiscal 2008. However, it said the trading environment
remains volatile given higher fuel prices, food inflation and interest rates. Metcash, which supplies groceries to
independent operators under banners including IGA and Foodworks, grew its market share to 19.2% from
18.6% during the year. Revenue for the year to April 30 rose 4.5% to $10.2bn, from $9.7bn a year ago. The
company declared a final dividend of 12 cents a share, up from 10 cents a year ago.
Origin Energy (ORG) Chairman Kevin McCann said that news of the deal between Petroliam Nasional and
Santos (STO) was central to the company's decision to reject a revised $13.62bn takeover offer from BG
Group. McCann said Origin had been happy with the $15.50 a share offer being made by BG on Wednesday,
but had changed its mind by Thursday. "We of course had the benefit of the news of yesterday which, when we
took that into account with the valuation, led us to conclude that the proposal was no longer in our
shareholders' interests," he said. Origin Chief Executive Grant King said, based on the prices paid by Petronas
for a stake in Santos' coal seam gas reserves, Origin's proven, probable and possible gas reserves would be
worth about $16bn. King said Origin has been approached by credible liquefied natural gas players and intends
to aggressively pursue options to monetise its coal seam gas reserves.
Perpetual (PPT) announced that its chairman provided an operating profit after tax outlook for the company of
between $130-140m for the 2008 financial year. It advised further that this result is premised on the All
Ordinaries Index remaining at its current level. The global credit crisis and the decline in share markets
continued to drive market volatility and negatively impact investor sentiment in the second half of the 2008
financial year. Funds under management in Perpetual Investments were $32.6bn at 30 April 2008, a decrease
of 17% since 30 June 2007. Funds under advice in Perpetual Private Clients were $8bn at 30 April 2008, a
decrease of 5% since 30 June 2007. Funds under administration in Perpetual Corporate Trust were $195.6bn
at 30 April 2008, a decrease of 7% since 30 June 2007.
St. George Bank (SGB) and Westpac Banking Corporation (WBC) announced that, following the successful
completion of due diligence by both organisations, they have signed a Merger Implementation Agreement. This
reflects the key commercial terms which have been agreed by the boards and under which the recommended
proposal will be put to a vote of St.George shareholders. The Company reported creating Australia's leading
financial services company for customers, shareholders and employees; St.George shareholders to receive
1.31 Westpac shares for each St.George share; retaining St.George, BankSA and Asgard brands with no net
reduction in ATM or retail network; and AA rated financial institution, with strong capital and broad based
funding.
Westpac Banking Corporation (WBC) reported Cash NPAT up 10% to $1,839m for the half-year ended 31
March 2008. Statutory NPAT was $2,202m, up 34% on pcp. The company advised that the result was due to
its conservative balance sheet positioning, strong risk management culture and prudent liquidity profile.
Revenues from ordinary activities were $5,794m, up 18% from last year. Diluted EPS was 115.2 cents
compared to 88.7 cents last year. Net operating cash outflow was $3,227m compared to $3,326m in the pcp. A
fully franked interim dividend of 70 cents has been declared, an 11% increase on the pcp. Westpac expects the
sector to have slower loan growth, higher impairment charges in both consumer and business segments,
continuing market volatility and for higher funding costs to persist. The Company has commenced a renewal of
its strategy with a focus around significantly improving the customer experience.
Challenger Infrastructure Fund (CIF) said it has ended talks with UK suitor Arkmile and sold its 6.5% interest
in radio and TV infrastructure company Arqiva to Macquarie Group Ltd (MQG) funds for GBP129.8 million.
Arkmile, a subsidiary of UK-based property investor Consensus Business Group, in March made a $3.50 a
security takeover offer for Challenger Infrastructure, valuing the fund around $1.06bn. Brenda Shanahan, the
chairman of the fund's operator, Challenger Listed Investments Ltd., said that there have been extensive
                                                         3
discussions and correspondence with Arkmile and its advisers, but Challenger Listed Investments "hasn't yet
received a formal proposal in a form capable of being put to securityholders". "The Challenger Listed
                                                                                                            Page 3
                                                                                                         4

Investments board doesn't anticipate receiving an acceptable proposal in the near term and has decided not to
continue discussions with Arkmile in relation to its approach," Shanahan said in a statement. "Consensus
Business Group has indicated that it will continue to assess its options and it remains a supporter of the fund
and a committed investor in Challenger Infrastructure Fund," she said.
QBE Insurance Group (QBE) announced that it has withdrawn its proposal for a merger with IAG after IAG's
Board formally rejected its proposal. The company reported further that it understands that its final proposal on
price was well short of IAG's expectations. The company advised that it will now continue to focus on the
pipeline of acquisitions that have been accumulating in recent months.
Amcor (AMC) announced that it will build a third glass furnace at its wine bottle plant at Gawler, South
Australia. The new furnace will cost $150m and be completed during the first half of calendar 2010. The site
will have three furnaces with an annual capacity of 600m wine bottles.
Leighton Holdings (LEI) announced the State Government has pressed the go button on Australia's largest
road infrastructure project. Premier Anna Bligh and Deputy Premier Paul Lucas announced BrisConnections as
the preferred bidder to build Airport Link, the next section of the Northern Busway and a new fly-over road to fix
the gridlocked airport roundabout. Airport Link - which is the most complex road and tunnel engineering feat in
Qld's history will cost over $3.4bn to build. In total the three projects will cost $4.8bn, including land costs, of
which the State will only contribute $1.5bn instead of the $2.37bn which the state had budgeted for. The
Premier said that the combined roads and busway solution construction of Airport Link and the Northern
Busway will start later this year and all three roads will be completed mid 2012.
Wesfarmers (WES) announced annual price negotiations for metallurgical coal exports from Wesfarmers
Resources Curragh mine in Queensland's Bowen Basin have now been concluded with all major customers.
The weighted average US$FOB contract price for Curragh's metallurgical coal sales - hard coking, semi-hard
coking and PCI - has increased by almost 230%. The sales mix remains unchanged from advice previously
given.
Commonwealth Bank of Australia (CBA) provided its third quarter trading update. CEO, Ralph Norris stated
that the Group achieved good volume and share gains in its banking businesses and is well positioned to
continue to grow in an environment where the Company is beginning to experience a slowing in underlying
credit growth. The Company's Wealth Management business demonstrated the strength of its brand and its
distribution capabilities by recording positive net inflows. However, difficult trading conditions in equity markets
will clearly have a negative impact on second half earnings. The Company is continuing to invest for medium
term growth and productivity, as evidenced by the recent announcement to replace the Company's core
banking systems. Further, the Group completed its long term wholesale funding programme for the current
financial year in April, and maintains a prudent liquidity buffer as a contingency.
Coca-Cola Amatil (CCL) provided an update at its Annual General Meeting on current business performance
as well as an update on the full year outlook for 2008. The Company reported the Australian business is
expected to deliver high single digit earnings growth in the first half, driven by a solid improvement in case
rates and despite weaker volumes experienced in the first four months of the year - price increases taken in
January as well as the benefit of mix improvements are expected to drive a case rate increase of between 4%
and 5% in the first half of 2008; New Zealand has had a strong start to the year with good volume and revenue
growth, buoyed by a hot and dry summer as well as improved pricing and mix; the Indonesian operations
continue to drive the shift into the more defensive and higher margin modern foodstores channel; and the
Company continues to focus on managing the key variables of volume, price and mix with the target of
maintaining group operating margins.
CSR said that its net profit for the year ended March 31 declined 35% from a year earlier to $177.4m. Full-year
sales rose 4% to $3.23bn, according to the country's third-largest maker of building products. CSR, which
makes bricks, roof tiles, fibre cement, plasterboard and insulation, is also Australia's largest sugar refiner,
produces ethanol and renewable electricity, smelts aluminium and develops property. It posted earnings before
interest and tax of $386.3m in fiscal year 2008, down 5% from a year earlier. In September CSR reiterated its
pretax earnings would be 5% lower than fiscal 2007 because of lower sugar prices and wet-weather delays to
cane crushing. "CSR made good progress this year in strengthening all our key businesses and adding a
substantial earnings stream through the glass acquisitions," said Chief Executive Jerry Maycock in the
statement.
                                                         4


                                                                                                             Page 4
                                                                                                       5

The Economy and Markets: The Federal Budget
The Rudd Government s first Budget seems after some inspection to be the quintessential foreign af-
fairs bureaucrats budget: little in the way of substantial new policy for either investors, business, or
households from what has already been announced but a lot of what will be seen to be quite irritating
and conflicting detail. The outlook for inflation over 4% to late 2009 and the RBA s attitude points to an-
other 0.25% rise in the cash rate target through mid 2008. The $A looks set to test $US1.00 while we
retain our fair value for the All Ordinaries at 7,200 for end 2008.
Background: Cautious Forecasts
The Budget projects a cash surplus of $21.7 billion, 1.8% of Australian output, as measured by Gross
Domestic Product, in 2008/09. While a record large cash surplus in both nominal dollars and as a share
of GDP since 1999/00, it is quite likely it is understated for a number of reasons.
First, Governments, Treasuries and Finance Departments, like to err on the side of caution in their eco-
nomic and financial forecasts. Better that actual outcomes on the economy, employment and revenue
are stronger than expected than weaker. For example, there are generally less grumblings about miss-
ing the forecasts when more people are employed than initially forecast compared with the situation
when employment is weaker than forecast.
Being cautious on the economic outlook also tends to produce a cautious forecast for the Budget out-
come. A smaller surplus tends to limit calls for further tax cuts or more spending. Better to have the flexi-
bility for either later than be committed upfront.
The interest rate outlook also suggests a political bias for initially being conservative. The forecasts of
output growth and inflation would not want to be seen to be above the top of the range of what the Re-
serve Bank considers appropriate to get inflation back within its 2-3% range. At the same time, a new
Government wanting to cement its economic management credentials would not want to be projecting
recession.
The economic parameters for 2008/09 point to this tension. We reproduce on the next page the main
economic and financial forecasts in the Budget.
Economic Growth Outlook
The forecast for real economic growth by June qtr 2009 in the non-farm sector is forecast at 2%, some-
what weaker than the 2.25% forecast by the RBA in its May Statement on Monetary Policy. The CPI in-
flation forecast in the Budget for the year to the June qtr 2009 is 3.25%, compared with the RBA s 3.5%.
Both inflation forecasts are based on international oil prices averaging around $US115 per barrel in
2008/09.
Both the non-farm growth rate and the inflation forecasts in the Budget seem too low and are based on
a very large deceleration in each through to June 2009. While household spending has slowed in recent
months, the 2008/09 outlook seems too weak with the tax cuts, increased family rebates and the strong
rise in immigration which is focussed on the skilled, and presumably, higher paid.
There also seems little indication at this stage that business investment will slow as quickly as forecast.
Commodity prices are set to remain high, international involvement in local mining and energy develop-
ment looks set to increase and company profitability remains at record levels.
Public investment also looks likely to be growing faster rather than slowing down. This is on the basis
of the 20% or so nominal increases in infrastructure spending for 2008/09 announced in the NSW, Qld
and various State Government Budgets released to date. The aggregated intending infrastructure
spending of the States is likely some $45 billion, about 4-5% of forecast Australian Gross Domestic
Product for 2008/09.
After decades of neglect, public infrastructure is getting a welcome boost. It is just a pity it is coming
as private investment booms. Whether the public infrastructure as planned gets actually built in 2008/09
is debateable with the existing construction capacity constraints both in Australian and globally. It is cer-
tain, however, the spending plans will be adding to demand and inflationary pressures and inflationary
expectations.
It is the rise in the latter that is the concern for the RBA. The table below that a broad range of inflation-
ary expectations have risen over the last year to now be at or well above the RBA s 2 to 3% pa target
                                                          5
range for inflation.

                                                                                                            Page 5
                                                                                                  6


To slow the non-farm economy to a 2% real annualised growth rate through 2009 as a precursor to re-
ducing inflationary expectations is why the discretionary parts of the economy such as retail spending
and housing will have to bear the most stress of slowing spending. This is because public and private in-
vestment and exports have to be given the space to grow.
While not likely said explicitly, the RBA would see it as more important labour and capital are used to
construct bridges, ports, railways and mines rather than build houses and shops. In an environment
where both labour and capital are in short supply and productivity growth has slowed, that may well re-
quire a contraction in money spent, and labour and capital employed, in housing and retail.
This is where immigration is a two edged sword. The Government announced in the Budget that perma-
nent immigration places for 2008/09 are to increase by 30,000 skilled and 6,500 family reunion places to
190,000 from 153,000 in 2007/08. Together with the increasing birthrate, we estimate this will boost
population growth to over 1.7% per annum, about 0.5% pa faster than in the first half of this decade.
This increased skilled intake will add to productive capacity and productivity. But it will also add in
2008/09 to the pressures on an already stretched housing sector and lift retail spending.
All this together points to at least another 0.25% lift in the Reserve Bank s cash target in July or Au-
gust. That should be the peak with expectations then shifting through late 2008 and 2009 that inflation,
and interest rates, will be on the way down from late 2009.
These favourable expectations would be assisted, as we project, by wages costs continuing to grow
around 4% and increasing productivity growth. The ABS Labour Price Index estimates for the March
Quarter show a national rise in the Wage Price Index of 4.1% over the year. This pace of change is virtu-
ally unchanged over the last three years, despite the rising skill shortages and lower unemployment.
While WA s growth was 5.9%, the growth in NSW and Victoria was 3.7%.
With some early signs that productivity growth in the market sector is recovering to 1.5 to 2% per annum,
this would imply inflation returning to under 3% in 2009/10 after the recent large increases in energy and
food prices wash through. The trick is not to have inflationary expectations, and wage gains and business
pricing, ratchet up to compensate for these pass through events. We believe that by taking the necessary
pain now that task will be achieved.
On share prices, we continue to see 7,200 on the All Ordinaries Index as fair value by December
2008. The March Quarter 2008 National Accounts indicate that Australian business remains very profit-
able with the Gross Operating Surplus of Corporations (GOSC) up around 2% in the quarter while pro-
ductivity also lifted 2%.
Our estimate of the fair value range is based on the GOSC rising 8% over the year to the December
quarter. Price to Earnings Ratios continue to fall as share prices ease and earnings results on average
come in ahead of expectations. We are still in that unusual situation where the outlook is for before tax
dividend yields on bank shares to be above the cash interest rate. Either analysts have got the earnings
outlook terribly wrong or Price to Earnings Ratios are far too low in the context of the medium term out-
look for inflation and interest rates. We believe it is the latter.




                                                    6


                                                                                                       Page 6
                                                                                                                           7
      Corporate
      GOS, $m
                                     Australian Share Prices & Profits                                                           S&P 500
 80,000
                                                           Source: ABS, ASX                                                             8,000
                                                                Research forecasts of Australian corporate
 70,000                                                            gross operating surplus in light blue                                7,000

                                                                                    Research "Fair Value"
 60,000                                                                             December 2008 7,200                                 6,000


 50,000                                                                                                                                 5,000


 40,000                                                                                                                                 4,000


 30,000                              S&P 500 Right axis                                                                                 3,000

                                                                                                              Corporate Gross
 20,000                                                                                                      Operating Surplus,         2,000
                                                                                                             Australian Bureau
                                                                                                                of Statistics
 10,000                                                                                                          Estimates              1,000
                                                                                                                  Left Axis

        0                                                                                                                               -
       July-49   July-54   July-59   July-64   July-69    July-74   July-79   July-84   July-89    July-94   July-99   July-04   July-09

Bond Yields &
                                 Australian Share Prices & Interest Rates                                                Share Price
 Inflationary
                                                    Source: ABS, ASX, RBA                                               Earnings Ratio,
Expectations,
     % pa                                                                                                                  Trailing
20                                                                                                                                          0
                                                                                                                                            2
18                                                                                       2008/09 forward P/E on
                                                                                                                                            4
                                                                                        Earnings Growth of 7% pa
16                10 Year Bond Yields, Left Axis                                                                                            6
                                                                                                                                            8
14
                                                                                                                                            10
                                                         All Ords Price/Earnings Ratio, Trailing to Date,
12                                                                                                                                          12
                                                                           Right Axis
                                                                                                                                            14
10
                                                                                                                                            16
8                                                                                                                                           18
                                                                                                                                            20
6
                                                                                                                                            22
4                                                                                                                                           24
           Market Inflationary Expectations,                                                                                                26
2                       Left Axis                                                                                                           28
0                                                                                                                                           30
Dec-82                 Dec-87                  Dec-92                   Dec-97                    Dec-02                Dec-07
                           Australia, Spending Growth & The Cash Interest Rate
                                         (Source ABS, RBA, PSL forecasts for 2008 & 2009 )
      %
 30       Australian Gross National Expenditure, Current Prices, Seasonally Adjusted, Year to Growth
          Reserve Bank of Australia Cash Rate
 25

                                                              Implied Budget 2008/09 Nominal Growth Forecasts
 20


 15


 10


 5
                                                                    7
                                                              Research Forecast Cash Rate July 2008 7.5%
  0
 June-72 June-75 June-78 June-81 June-84 June-87 June-90 June-93 June-96 June-99 June-02 June-05 June-08

 -5
                                                                                                            8
                            US Corporate Profits & Share Prices
1800                                           Source: BEA, WebIress                                                     1800
                                                                                     Research Profits' Forecast

1600                                                 Research "Fair Value" December 2008, 1,600                          1600

1400                                                                                                                     1400

1200                                                                                                                     1200

1000                                                                                                                     1000
                                                    S&P 500 Index, End Quarter
  800                                                                                                                    800

  600                                                                                                                    600

  400                                                                                                                    400

                                                                      US Corporate Profits, Before Tax with
  200                                                                    inventory valuation and capital                 200
                                                                        consumption adjustments,$US b
      0                                                                                          0
      Dec-47 Dec-52 Dec-57 Dec-62 Dec-67 Dec-72 Dec-77 Dec-82 Dec-87 Dec-92 Dec-97 Dec-02 Dec-07

                                     Australian and US Interest Rates
                                         Source: RBA and USA Federal Reserve Board
  10
               Aust RBA Cash Rates                                       Aust 90 Bank Bills
      9        Aust 10 year Govt Bonds                                   USA Federal Funds
               USA 3mo Certificates of Deposit, Secondary Market         USA 10 Year Govt Bonds
      8

      7                                                         Australia: Inverse Yield Curve

      6

      5

      4

      3
                                                                           USA: Positive Yield Curve
      2

      1

      0
      Dec-00       Dec-01          Dec-02       Dec-03          Dec-04         Dec-05           Dec-06      Dec-07

                        $US per $A, Commodity prices & US Inflation
2.0                            Sources: www.crbtrader.com, www.bls.gov, RBA, PSL                                         $1.80
1.9                                                                                                                      $1.70
1.8                                                                                                                      $1.60
1.7
                                                                                                                         $1.50
1.6
                                                                                                                         $1.40
1.5
1.4                                                                                                                      $1.30

1.3                                                                                                                      $1.20
1.2                                                                                                                      $1.10
1.1                                                                                                                      $1.00
1.0                                                                                                                      $0.90
0.9
                                                                                                                         $0.80
0.8
                                                                                                                         $0.70
0.7                                                         8
0.6                                                                                                                      $0.60
                $US CRB Spot Plus Oil & Gold/$US US PPI: Left Axis, 1982-1984=100
0.5                                                                                                                      $0.50
                $US/$A: Right Axis
0.4                                                                                                                      $0.40
 Jan-63        Jan-68     Jan-73      Jan-78      Jan-83     Jan-88        Jan-93      Jan-98      Jan-03       Jan-08
                                                                                                              9

Four Interims and a Merger - The Bank s Reporting Season: Travis Adams
The banks have reported their interim results though the difficult period since the credit market crisis came to light. The
market expected reductions in cash earnings and substantial increases in provisions.
The reporting season delivered slower growth and some provision increases. We were pleasantly surprised with the
results with provisioning increased but below the level the market expected. Cost to income ratios also fell indicating the
banks have reduced the cost of doing business and allowing the reduced levels of revenue growth to fall to the bottom line.
The growth rate of earnings fell due to higher funding costs and cash earnings in most cases grew.
The biggest surprise was the merger proposal between Westpac and St George. In hindsight this should not have been
such a surprise with the Westpac CEO, Gail Kelly having most recently been CEO at St George. Kelly is sure to be well
versed in the operations of St George with both operations having an Australian banking focus and investment operations.
Overall the Australian Banking sector is weathering the credit crisis well.
Westpac Banking Corporation (WBC): Westpac has been our favoured bank
based on our qualitative assessment and delivered a "robust" result of cash
earnings per share up 8% for the half year to March 2008 on the pcp. Recent
times have seen the share price fall due to the St George merger proposal but we
believe it has the best quality management and is able to deliver high EPS growth
in the mid to high single digits through 2008. We rate WBC a Buy.
Having a initial look at the Westpac (WBC) result, it appears "robust" as described
by the company. Westpac has increased its provisions by $201m to a total of
$433m, while being able to deliver an increase in cash earnings of 10% and cash
EPS growth of 8%.
WBC's impairment charges compared to average loans is an increase of 30 basis
points with provisions now back to 2003 levels after hitting a cyclical low in 2005.
Stressed loans are returning to long term averages.The chart shows the stressed
exposures of Westpac through recent years.
Despite the provision increase, WBC has been able to increase cash earnings
10%. We expect this result to be the best of the big four banks with some
questions surrounding the NAB result and exactly what provisions they may have.
St George Interim Result: Economic conditions have tested the credit
provisioning of banks but St George has reported minimal increases for the half
year to end March 2008. Earnings were negatively affected by equity market falls
in their insurance division and a provision for an adverse and once-off tax ruling.
Guidance for cash earnings per share for 2008/09 was reduced from above 10%
to 8 - 10%. Asset quality remains extremely strong with no increases in provisions for residential and consumer doubtful
debts and some reductions in other areas.
SGB is the best positioned regional bank with strong asset quality, capital and liquidity positions allowing SGB to pursue
and deliver earnings growth during difficult times. Buy on the back of strong underlying banking result and prospective
6.5% fully franked dividend yield.
SGB performed well despite falling equity market performance adversely impacting the insurance division. The SGB result
included:
   NPAT fell 10.1% after taking into consideration significant items, the largest being provision for additional tax payable
   of $117m due to disallowance of previously claimed deductions for interest expense on hybrid capital;
   Backing out one-off items such as this Tax impact, Restructure costs and gains on the sale of the Visa holding, cash
   NPAT increased 6.2% and cash earnings per share rose 2.1%;
   Underlying business earnings (excluding the St George Insurance equity portfolio falls) increased 13.2%;
   Bad and Doubtful Debts provisions expense increased by $33m, with $20m due to margin loans to Octavia (formerly
   MFS) and $14m for the Collective Provision. Specific provisions expense for Residential, Consumer and Commercial
   was the same as the Sept 2007 half year.
   The record low cost to income ratio of 41% compared to WBC 44%, CBA 48%, and ANZ 44.4% in the most recent
   half;
                                                             9
   Interest margin reduction of only 5bps to 1.92% despite higher wholesale funding costs compared to WBC 20bps fall
   to 2.05%, ANZ 25bps fall to 1.99%, CBA fell 5bps to 2.17%;
   The high return on equity of 21% versus ANZ 15.1% CBA 18.1% and WBC 22% and;
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   Funding profile having raised equity last year.
National Australia Bank Result: National Australia Bank surprised the market cash earnings growth of 8%, NPAT growth
of 26%, and a dividend increase from 87c to 97c in a difficult climate. NAB s provision expense has increased as credit
market conditions trouble the sector. Continued flat divisional expenses allowed for the increase in cash earnings and
should continue to be NAB s major strength. A weakness is the exposure to the UK and soon to be US banking sectors.
The US has not been a happy hunting ground for NAB and economic conditions may hamper returns.
NAB s headline result was a surprise with statutory net profit after tax (NPAT) rising significantly. The NAB result included:
   NPAT rising 26% after significant items. This included a gain on the Visa Share IPO and non cash earnings adjustments
   which included a further below the line charge for bad and doubtful debts of $214m as an economic cycle adjustment .
   When questioned about this the CEO, John Stewart, said it was a charge for unforeseen losses in the portfolio after a
   deep dive review into the credit quality of individual exposures within the conduits used for securitization. We
   wondered if it should be above the line and had been used to smooth earnings.
   Cash Earnings increased 8% on the March Half 2007 result but declined 3.4% from the September Half of 2007. Diluted
   Cash Earnings per Share increased by 8.7%. Dividends increased from 87c to 97c.
   Bad and Doubtful Debts provisions expense increased by $326m to $736m. Specific provisions increased by $332m
   including an $80m exposure to Allco Financial Group, and the collective provisions increased by $417m including the
   extra $214m economic cycle provision . Total provisions now stand at $3bn.
   Expense growth remained flat in many of NAB s operating units allowing revenue growth to drop through to earnings.
   NAB s cost to income ratio for the banking division was 47% down from 51%. This compares to SGB at 41% WBC at
   44%, CBA at 48%, and ANZ at 44.4% in the recent half and;
   Interest margins reduced by 15bps to 2.18% for the group compared to SGB falling 5bps to 1.92%, WBC 20bps fall to
   2.05%, ANZ 25bps fall to 1.99%, CBA fell 5bps to 2.17%
NAB has been able to increase cash EPS growth in a difficult period and maintained flat expense growth allowing revenue
increases through lending growth to fall through to earnings. NAB kept expense growth flat by changing the components of
staff benefits from fixed to at risk as well as off shoring and contracting functions where available. This is reflected in the
cost to income ratio fall.
NAB differentiates itself with exposure to the UK and US through the nearly completed purchase of Great Western Bank.
This clouds the outlook due to poor economic conditions in both these economies. In addition, US expansion in the past
has not gone well for NAB when combined with past poor governance ranks NAB as our least preferred bank. We would
prefer a focus on the Australian operations but overseas growth continues to be too great a temptation for NAB.
We rate NAB a Buy for a growing fully franked dividend yield of 6.7% and mid to high single digit growth.
We have rated NAB a Buy with the rest of the Big Four Banks but its US ambitions see it ranked as our least preferred Big
Four Bank.
Westpac Proposes Merger with St George.
Westpac has proposed a merger with St George. St George shareholders are to receive 1.31 Westpac shares per St
George Share under a scheme of arrangement. The merger is opportunistic and looks more like a takeover, with Westpac
shareholders giving up earnings to SGB shareholders in return for being shareholders in the largest Australian banking
group, the prospect of higher earnings per share and future growth opportunities.
The Terms: Westpac and St George have announced their intention to merge with the terms of the deal being:
   Westpac will pay 1.31 shares per St George share valuing SGB at $33.10 per share or $18.6 billion. This is a 28.5%
   premium based on the closing prices of May 9th;
   The St George Board is recommending the merger to its shareholders which will be completed through a scheme of
   arrangement;
   St George Shareholders will not receive the WBC dividend of 70c but will receive the SGB interim dividend of 88c and
   the SGB final dividend that is yet to be declared;
   The merger is expected to be cash earnings accretive for St George shareholders in the first year and for Westpac
   shareholders within three years of the merger; and
   Full capital gains tax rollover relief is expected to be available for St George shareholders.
The deal will create Australia s largest bank should the transaction be approved. Earnings are estimated to be around $5
billion. The main risk to the transaction is the regulatory and shareholder approval
The table on the left shows the merger diluting WBC earnings by around 10 cents per share in order to acquire SGB. WBC
                                                           10
hopes to make that difference up in the next 3 years though cost savings.
We have used Aspect Huntley s estimated earnings for 2008 and 2009 full years. We estimate the merger should be able

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                                          to deliver cost savings which reduce the cost to income ratio for the combined
                                          group by 1%. SGB in the most recent half had a cost to income ratio of 42.5%
                                          while Westpac s was 44.4%. The industry benchmark is under 40% This cost
                                          saving gives savings of $117m in 2009 for an increase in earnings per share of
                                          5c
                                          SGB holders receive an increase of 13% in earnings per share if the merger
                                          goes ahead, compared to stand alone pre-transaction earnings. There should
                                          also be benefits through operational synergies and growth prospects of the
                                          larger group.
                                          The merger strategy is to maintain separate branding of Westpac, St George,
                                          BankSA, RAMS and BT while combining the retail and institutional banking back
                                          offices. Westpac CEO Gail Kelly was previously CEO of SGB for 5 years and
                                          has intimate knowledge of the business.
We like WBC s focus on running Australian banking and funds management operations with solid management and Gail
Kelly has proven herself at SGB.
WBC is our preferred long term banking exposure with a focus on Australian operations which is reinforced by the merger.
The benefits for WBC shareholders are long term in nature. SGB shareholders should approve the takeover scheme and
we rate WBC as a Buy.
The Sector There are some headwinds such as slowing economic growth, which is hurting consumers and higher funding
costs which will likely put further pressure on the banks. However, non bank lenders are likely to be feeling even greater
pressure. The banks are taking market share on lending and funds raising away from the non banks, as well as
decreasing commission payments to loan brokers.
In order to try and maintain margins, the banks are also passing on to borrowers some of their increased credit and other
funding costs. We expect this to continue through the remainder of 2008 although with declining competition, interest
rates nearing their peaks and early indications of credit spreads starting to ease, most of the margin loss has likely already
occurred. Fees are also being hiked as further offset to the margin losses.
Looking forward we expect the big four banks to increase earning per share through the current difficult environment. This
is quite an achievement compared to its international peers and reaffirms our view that the Australian banking sector is
well positioned to weather the difficult banking environment. System growth is likely to be slower than past years but we
expect EPS to increase.
Our preferred bank is Westpac due to the focus on Australian Banking, with CBA and their high proportion of deposit
funding ranked second. ANZ has a focus on Asia and their poor lending practices of the past are catching up with them.
NAB has an international focus in the UK and the US strengthened by the purchase of Greater Western Bank in the US.




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Economic and Financial Forecasts
                                                                     2003      2004       2005    2006    2007 2008F 2009F
Real GDP Growth, pa (Calendar Year)
USA                                                                  2.5%     3.6%      3.1%      2.9% 2.2% 0.5%             0.6%
Japan                                                                1.4%     2.7%      1.9%      2.4% 2.1% 1.4%             1.5%
Euro Area                                                            0.8%     2.1%      1.6%      2.8% 2.6% 1.4%             1.2%
New Zealand                                                          3.4%     4.5%      2.8%      1.5% 3.0% 2.0%             2.1%
China                                                               10.0%    10.1%     10.4%     11.1% 11.4% 9.3%            9.5%
India                                                                6.9%     7.9%      9.1%      9.7% 9.2% 7.9%             8.0%
ASEAN 5                                                              5.2%       6.1    5.21%      5.6% 6.3% 5.8%             6.0%
Africa                                                               5.3%     6.5%      5.7%      5.9% 6.2% 6.3%             6.4%
World                                                                3.6%     4.9%      4.4%      5.0% 4.9% 3.7%             3.8%
Private Consumer Inflation, pa
USA                                                                  2.3%     2.7%       3.4%     3.2%    2.9%     3.0%      2.0%
Japan                                                               -0.3%       0%      -0.3%     0.3%      0%     0.6%      1.3%
Euro Area                                                            2.1%     2.1%       2.2%     2.2%    2.1%     2.8%      1.9%
New Zealand                                                          1.7%     2.3%       3.0%     3.4%    2.4%     3.4%      2.7%
China                                                                1.2%     3.9%       1.8%     1.5%    4.8%     5.9%      3.6%
India                                                                3.8%     3.8%       4.2%     6.2%    6.4%     5.2%      4.0%
Other Indices (end June) (PSL Forecasts 2007)
USA S&P500                                                         989.8    974.5     1140.8 1191.3      1270     1450      1675
USA Federal Funds, % p.a.                                           1.75     1.22      1.03      3.04    5.25      2.25      4.50
10 year US Federal Treasury Bond Yields %                           3.33     4.73      4.62      5.11    5.10       3.5      4.5
Crude Oil, (WTI, Brent, Dubai Fateh) $USbbl                         27.9     35.5      53.9      68.3    68.2      110        90
Sources: Economic growth and inflation estimates from International Monetary Fund April 2008 World Economic Outlook, www.imf.org;
ASEAN 5 from ASEAN Secretariat and IBRD; USA S&P 500 from www.standardandpoors.com. USA interest rates from
www.federalreserve.gov. Crude oil prices from www.imf.org.

                                                                  Australia (Financial year ending June) (PSL Forecasts 2008)
Real Gross Domestic Product growth*, p.a.                           3.2%     4.1%      2.7%      2.9%    3.2%     4.0%         4
Consumer Price Index change*, p.a. (Year                            2.7%     2.5%      2.5%      4.0%    2.1% 4.25% 3.5%
Company Profits (Gross Operating Surplus of Private
Non-Financial Corporations and Financial Corporations), current
prices*, growth, p.a.                                              10.4%     9.7%      9.2%      12.8% 14.4%        8%       8%
Private Bus Investment *, current prices,                          16.3% 9.0% 12.4% 17.7% 8.3% 15% 10%
Dwelling Starts (000)*                                             170.5 174.4     160.1  151.2 151.7 160     175
Retail Turnover, current prices*, growth, pa                       6.7%    8.6%    4.0%   4.4%  6.5% 6.5% 7%
New Motor Vehicle Sales (000)*                                     860.5 940.1     981.8  971.4 1,004 1,050 1,100
90 day Bank Bill Yields % (end June)**                              4.67    5.49    5.66  5.96   6.42   8.00 7.25
10 Year C wealth Bond Yields % (end June)                           5.01    5.87    5.11  5.79   6.26   6.25 6.50
S&P 500/All Ordinaries Index (end June) ***                        2,999. 3,530.3 4,229.9 5,034 6,310. 6,000 7,400
$US/AUD (end June) **                                               0.67    0.69    0.76  0.74   0.85   0.95 0.95
Sources:
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*Australian Bureau of Statistics, ** Reserve Bank of Australia, *** Australian Stock Exchange



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