- Westpac (WBC) has reported 1H19 cash earnings of $3,296m, in line with our expectation. An interim dividend of 94cps fully franked has been declared, also in line with our expectation.
- One of the highlights of the result is that Westpac's Australian Consumer Bank has outperformed peers in our view.
- WBC remains our preferred major bank as we believe it remains undervalued relative to major bank peers.
Australian Consumer Bank outperforms peers
Of the banking businesses of the major banks, we believe the operating environment has been most difficult for Australian retail banking. In light of this backdrop, we are pleased with the performance of WBC's Consumer Bank.
Excluding large notable items, cash earnings for this division was only down 0.5% from 2H18 to 1H19, compared with down 13% for NAB's Consumer Bank and an estimated ~10% reduction for ANZ's Australian Retail bank.
We believe at least some of WBC's relative share price weakness following 1H19 result announcements from ANZ and NAB was due to negative read-throughs for WBC's Consumer Bank.
However, with the performance seen today from the Consumer Bank, we believe WBC's relative share price weakness is not justified.
Expense targets reiterated
WBC has reiterated its target of 1% expense reduction from FY18 to FY19 (excluding provisions for remediation and wealth reset). WBC has also reiterated its target of $400m of productivity savings in FY19. We note that WBC reduced the number of full-time staff by 2% over 1H19.
We continue to see underlying cost reduction as a source of underlying earnings upside for the major banks sector.
WBC remains our preferred pick
Concerns about the asset quality and margin ramifications of WBC's relatively high interest-only (IO) home loan exposure continue to weigh on WBC's share price multiples in our view. However, we continue to believe these concerns are overblown.
WBC has reduced its IO exposure from 50% of its Australian home loan book at Mar-2017 to 31% at Mar-2019 without its asset quality underperforming peers in any material way and its group NIM has been up slightly over this period.
While we acknowledge that switchings from IO to principal & interest (P&I) are margin headwinds, we expect the impact of the switchings on ROE to be more muted once APRA announces its new capital framework.
Also, we believe the bearish views on WBC's IO exposures have generally not accounted for the fact that a significant chunk of the exposure reduction over the last two years is attributable to external refinancing, and we expect this to continue to be the case over the next two years as long as securitisation markets remain buoyant.
Investment view and changes to forecasts
We have made no material changes to our cash EPS forecasts.
We retain an Add recommendation. Our target price, based on our DDM valuation, is unchanged (available here Morgans client only).
Key downside risks include greater-than-expected asset quality deterioration.
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