Westpac result shows stock is undervalued

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
07 May 2019, 2:45 PM
Sectors Covered:

  • 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.

More information

Morgans clients can login to view our detailed report and share price target for Westpac Banking Corp (WBC). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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