Key points

• Westpac wants to drive the expense to income ratio below 40% in the next three years (currently 42.5%) and reduce the rate of growth in expenses to 2% to 3% per annum.
• This is largely a new senior team at Westpac, and given that technology is Westpac’s Achilles’ heel, it will be many months, more likely some years, before we really know just how good a job Westpac has done.
• Which bank? The differences are at the edges. In a tight market, if you are looking to add to your bank holdings, consider NAB, then Commonwealth, then Westpac and lastly, ANZ.

It is telling that Westpac CEO Brian Hartzer chose to call his strategy briefing to the market last week “Unlocking Westpac’s Potential”. Read another way, this is an awful indictment on the previous management team, including the media-lauded Gail Kelly. Were they asleep at the wheel?

The most Australasian-focused of the four major banks, with 97% of gross loans from Australia and New Zealand, Westpac has a unique portfolio of brands. St George, BankSA, Bank of Melbourne, RAMS and BT make up the portfolio, in addition to the main Westpac brand. It is number one or number two in all key domestic markets.

However, Westpac is a long way behind market leader Commonwealth Bank in technology, customer service, and from a shareholder’s perspective, return on equity, and this is what Hartzer’s strategy is attempting to address.

The strategy is pretty straightforward:

• Drive the expense to income ratio below 40% in the next three years (currently 42.5%);
• Reduce the rate of growth in expenses to 2% to 3% per annum;
• Increase productivity savings to $270 million per annum, up 20%;
• Increase investment spend by $200 million to around $1.3 billion per annum to accelerate digitisation; and
• Re-organise around customers, rather than brands. A Consumer Bank, encompassing all brands, under George Frazis, and a Commercial and Business Bank (encompassing all brands) under David Lindberg.

All good stuff, no doubt. The market liked the idea of getting the cost to income ratio below 40%, but queried whether Westpac was really going hard enough on the expense front – a 2% to 3% growth rate doesn’t imply any real reductions in cost. And is a $200 million increase in investment really enough to close the technology gap?

Westpac is not yet making the leap to address its core systems challenges – one legacy system for Westpac and another legacy system for the St George Group.

CIO Dave Curran says that there are significant opportunities to leverage hybrid cloud technology, consolidate systems and share infrastructure to reduce IT costs and invest in such things as a single customer service hub, however, there are no plans to address the systems of record. Not yet, anyway.

As Commonwealth Bank discovered, it is hard to sustainably improve the customer service experience until you address the system of record issues. And with a multi-brand strategy in place, the dream of “one kitchen, many dining rooms” is likely to remain but a dream.

It is also possible that there could be further changes to the senior leadership team. Hartzer’s team of 12 direct reports looks lopsided – just five business heads compared to seven in support areas.

Like most strategies by companies operating in mature markets, success or failure for Westpac is ultimately about the ability to execute. This is largely a new senior team at Westpac, and given that technology is Westpac’s Achilles’ heel, it will be many months, more likely some years, before we really know just how good a job Westpac has done. Bottom line – too early to re-rate Westpac on the back of a single statement, but at least it is in the right direction. Pity it is not a bit more ambitious.

Which bank?

While there is no reason yet to re-rate Westpac, the question remains – which bank?

With Australian banking one of the great oligopolies, it is no surprise that the banks tend to move as a pack and that differences around strategy, organisation and business mix are at the margin.

Looking at performance, CBA has been the standout performer over the last decade. It has also performed best over the period I have been rating the banks in the Switzer Super Report. Over this period of 16 months, CBA has a marginally positive return of 2.23%. The other banks are all in the red – with ANZ the standout poor performer.

¹ Includes $0.09 per share for CBA 1:23 Rights at $71.50, which ceased trading at $2.01. ² Includes $0.40 per share for NAB 2:25 Rights at $28.50, which ceased trading at $4.99.

While I have been a big fan of the Commonwealth Bank, despite it being the most expensive on a PE basis, I revised my bank ratings in the 11 May edition of the Switzer Super Report to 1. NAB; 2. CBA; 3. Westpac; and 4. ANZ. Over this shorter period, CBA has again performed relatively better – losing 6.30% compared with Westpac’s 7.69%, NAB’s 10.28% and ANZ’s 14.93%.

Poor old ANZ!

The brokers

Following the recent price weakness, the brokers are now favourably disposed to the sector. All major banks have a positive rating. With sentiment measured on a scale of -1.0 (most negative) to +1.0 (most positive), Westpac is the most favoured at 0.6 and NAB is the least favoured. In terms of potential upside, ANZ is seen as having the most – 21.5% to reach the consensus target price.

CBA is by far and away the most expensive bank, trading on a forward multiple of 13.6 times 2016 earnings – an effective premium of almost 28% to ANZ.

Source: FN Arena as at 11/9/15. Sentiment scale (-1.0 to +1.0). Upside is to consensus target price.

My view

While the Brokers seem more favourably disposed to Westpac, with many noting the opportunity for Westpac to cut costs by rationalising its branch network, I feel it is premature to re-rate them. ANZ shares are super cheap – but my hunch is that they are going to remain cheap until a new CEO is appointed and their Asian strategy is clarified. Are they really on track to be a “super regional bank”?

I like that NAB CEO Andrew Thorburn has the organisation focused on a “back to basics” approach centred on Australian and New Zealand banking. They have drawn a line under their legacy businesses.

And despite CBA’s price premium, they keep delivering.

Bottom line – the differences are at the edges. In a tight market, if you are looking to add to your bank holdings, my rating is:

1. NAB
2. Commonwealth
3. Westpac
4. ANZ

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.