Buy Westpac before the result

Chief Investment Officer and founder of Aitken Investment Management
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If body language and enthusiasm from a CEO is any guide, and I think it clearly is, then I think we can look forward to a record set of numbers delivered by WBC in a month’s time. We also think the chances of another 10 cent special dividend are rising, due to Westpac’s excess capital/franking credit position.

The East Coast story

I am an unapologetic “super bull” strategically on the East Coast of Australia, as it comes out of a 5-year “feels like” recession. All the data is turning up and the ultra-low cash rate settings of the RBA are starting to translate to activity, as the missing ingredient known as confidence arrives post the decisive change of federal government.

Everything we have forecast 18 months ago about the East Coast of Australia is happening. What we didn’t forecast back then was a big jump in infrastructure spending post the change of government. That’s an added bonus.

I want to state unequivocally that rising residential property prices are good for Australian mortgage banks. I want to state unequivocally that rising residential property prices are good for Australian GDP growth. I think the East Coast economy is about to explode on the upside.

If you use the 8% rise in median house prices this year, Australia’s housing stock rose in value by $400 billion. That’s a massive positive wealth effect, remembering housing is the true driver of the wealth effect.

This is occurring as 55% of Australian mortgagees are ahead of scheduled repayments, Australian households are sitting on record cash levels, at record low cash rates, and have delayed discretionary purchases for many years because our friends in the press could only type one word, “crisis”, and we concurrently suffered from woeful political leadership.

Australian Banks are leveraged cyclical financials. They are GDP+ growth rate proxies. I want to again remind you of my self-fulfilling virtuous circle of bank equity demand ™ in an ultra-low interest rate environment.

The big calls

There is no other broking firm that has all four major Australian banks in its high conviction list, as well as Suncorp and Macquarie Group. We also have Bank of Queensland in our 20/20 list and a buy on Bendigo. The top down and bottom up view we are trying to transmit on Australian banks couldn’t be clearer, but rest very assured, we remain the outlier in this call as we have for the past two years.

At the top down level, I am sticking with my FY14 5.00% fully-franked yield based share price targets for the Big Four. Just to remind you what they are (set from forecasts that do not include special dividends):

ANZ $33.60
CBA $76.80
NAB $39.50
WBC $36.40

In terms of NSW banking exposure, the largest leverage lies inside Westpac, which is the Bank of NSW plus St George. 40% of Westpac’s lending is directly to NSW, while its NSW/VIC/QLD exposure is 82% of its mortgage book, a mortgage book that is 67% of its total lending book. Westpac commands 22% of the entire owner-occupied Australian mortgage market and 33% of the investor market. And 90% of WBC’s over $7 billion NPAT is generated from Australia, while in the 1H of FY13 Westpac lost just $53 million (net of insurance) in actual mortgage losses from a book of $321billion. Average loan size is $219,000, average dynamic LVR 48%.

Good numbers ahead

In simple terms, we expect a cracker of a result from Westpac from a very benign period. Those short Westpac must be willing to be short an 88 cents final dividend and 10 cents special dividend, plus the consensus FY14 upgrades that will follow the FY13 results. Good luck with that: even the DRP (dividend reinvestment program) now buys shares on market.

In terms of FY14, we have upgraded to an EPS forecast of $2.40. The chart below shows you current Westpac consensus for FY14 is $2.28. We are 5.2% above current consensus EPS forecasts for FY14 for Westpac, which is a big gap.

Tier 1 capital at 10.6% is the highest of the Big Four and why we now forecast a 10 cent special dividend on top of the final dividend.

Cost to income ratio is the lowest of the Big Four and one of the lowest in the world at 40.6%.

The analyst buy/hold/sell ratio on WBC is 7/8/4, while the median 12-month price target is $32.15, below the current share price.

WBC remains a high conviction buy and we strongly recommend being on the register before the FY13 result. At 7.92% of the ASX200 Index, WBC being re-rated is crucial to my 6,000 index forecast.

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.

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