Since the start of October, Westpac had rallied almost 17% making it the best performing major bank over this period. So on the basis of the old axiom “buy the rumour, sell the fact”, it was no surprise to see it fall today by around 3% when it delivered an “as expected” full year financial result. Moreover, there was nothing in the result to suggest that Westpac was in a position to rise up in the bank “pecking order”. It remains with the ANZ anchored a long way behind market leader CBA and the fast rising NAB.
Westpac (WBC) – last 12 months
Source: nabtrade
For the full year, cash earnings were down 1% to $5.3bn. Excluding “one -off” notable items (such as losses from the divestment of assets), cash earnings were down 6% from $6.9bn to $6.6bn, mainly due to higher credit impairment charges and interest margin pressures in the first half. But half on half, cash earnings rose from $3.1bn in the first half to almost $3.5bn in the second half.
The $3.5bn second half cash profit was right on market expectations. For shareholders, Westpac elected to pay a fully franked final dividend of 64c per share, up from 60c in FY21, which took the full year dividend to 125c per share. This is equivalent to a payout ratio of 67% of cash earnings excluding notable items, in the middle of Westpac’s range of 60% to 75%.
The improvement in second half performance was on the back of a higher net interest margin (NIM), which rose from an average of 1.70% (excluding Treasury & Markets) in the first half to 1.80% in the second half. The exit margin (for the month of September) was higher again at 1.85%. An increase in volumes, and lower expenses, also helped second half performance.
Highlights of the result included:
- Westpac grew its home loan book by 2% or a net $10.5bn over the half, giving it system growth. This was a considerable improvement on the first half. In comparison, ANZ achieved net growth in their home loans of $3.5bn in the September half;
- Business loans were up 5% from $80.9bn to $84.9bn
- Operating expenses were down 2% in the half year – a fall of $100m; and
- Bad debts (impairments) were up from $139m in the first half to $196m in the second half, still remarkably low by historical standards. At 5 basis points (0.05%) of average loans, this is about one quarter of the long run average.
Negatives included:
- The exit margin on NIM was 1.85% (0.05% higher than the half year). This was lower than the market was expecting, pointing to increasing competitive pressures in mortgages and depositors switching from saving accounts to higher cost term deposits;
- In relation to investment spend, the percentage of spending capitalised increased from 39% in FY21 to 56% in FY22. Increase capitalisation reduces (in the immediate 12 months) total expenses; and
- Westpac elected not to neutralise its Dividend Re-investment Plan (neutralising is buying the shares issued through the DRP back on the ASX to keep the number of shares unchanged). DRPs if not neutralised are dilutive, not normally favoured by analysts and institutional investors).
Looking ahead, Westpac is focussed on completing its “fix and simplify” agenda, which it says is well advanced. It headlined its outlook for FY23 as a “solid outlook, some uncertainty”.
CFO Michael Rowland summarised his message to the broker analysts as:
- Improved momentum across all banking divisions;
- Well capitalised, with levels near the top of Westpac’s target range; and
- Credit quality continues to “positively surprise”.
CEO Peter King announced that Westpac was scaling back its long term annual cost target of $8.0bn by FY24 to a revised $8.6bn. He cited higher inflation than initially assumed, plus the persistence of regulatory and compliance cost beyond FY23. While the $8.0bn target was viewed by the market as “aspirational”, the new target will require considerable work to achieve because costs will need to fall in nominal terms from $9.4bn in FY22 to $8.6bn in FY24.
Interestingly, Westpac will cease reporting profit on a ‘cash basis’ in FY23, adopting instead the ‘statutory’ method.
What do the brokers say
Going into the result, the brokers were largely positive on Westpac, seeing it as “cheap” compared to major bank rivals CBA and NAB. All brokers had either “buy” or “neutral’ recommendations. According to FN Arena, the consensus target price was $26.00, about 7.6% higher than Friday’s close of $24.15.
Broker Targets and Recommendations (as at 4/11/22)
Source: FN Arena
Following today’s in-line result, I expect the Brokers will make only very minor changes to earnings forecasts and target prices.
Bottom line
My sense is that there wasn’t enough in the Westpac result to warrant a positive re-rating.. With the focus still on “fix and simplify”, the potential for competitive pressures in the mortgage and deposit markets to erode gains in the net interest margin, and higher credit impairment charges over time, low to mid single digit earrings growth is the order of the day.
While this is interesting, it is not enough to abandon the relative security (and superior earnings outlook) of Commonwealth Bank or NAB. Accordingly, I expect Westpac to wallow somewhat until it becomes cheap relative to the others.
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