Morningstar banks analyst David Ellis has made a 6 per cent cut to his fair value estimate for Westpac (ASX: WBC) following its full-year cash earnings result.

The big four bank yesterday reported $8.07 billion in profits for the 12 months to 30 September, barely moved from $8.06 billion a year ago.

Ellis cites elevated costs from customer remediation and ongoing negative sentiment around the royal commission findings among his reasons for the reduction in fair value estimate – which declined to $33 a share, from $35.

However, Ellis emphasises Westpac remains Morningstar's preferred Australian major bank, still trading at a 19 per cent discount to the updated valuation, opening today's trading at $26.40.

Westpac's flat result came as management set aside $281 million for customer remediation and associated costs, as previously announced, stemming from the banking royal commission's findings.

Westpac bank big-four

Westpac's customer remediation bill remains low alongside big four peers (Pictured CEOs: Shane Elliott, ANZ; Matt Comyn, CBA; Bryan Hartzer, WBC; Andrew Thorburn, NAB)

While this figure is low compared to its peers ANZ and NAB – who have earmarked $421 million and $371 million, respectively – chief executive Brian Hartzer conceded there may be further fall-out.

"We're committed to running our business in a way that meets standards from customers and the community and we'll continue to look to improve things," Hartzer said.

"I'd like to say we're largely through it but it is possible there may be other issues."

Morningstar's reduced fair value estimate suggests Ellis tends to concur with Hartzer, but he believes positive fundamentals will outweigh negative sentiment.

Ellis says he likes the fact Westpac is the least exposed to "management distractions and organisation restructuring, compared with major bank peers. The balance sheet is strong and credit quality is a standout."

He also believes Westpac's wide-moat of competitive advantage intact, even in the context of the "intense pressure of the past nine to 12 months".

"Despite a very wide range of bad publicity, brand damage, the storm of the Royal Commission, political criticism, media hysterics and a breakdown in consumer trust in the major banks, Westpac increased net Australian customer numbers by 250,000 or 2 per cent during the 12 months ended 30 September 2018," he says.

Morningstar's dividend outlook of $1.90 a share, fully franked, for fiscal 2019 and 2020 remains unchanged; and grossed-up dividend yields of 10 per cent "provide some valuation support" to Westpac's share price.

Effect of housing downturn

As Australia's second-largest lender, the weakening housing market is a key factor in Morningstar's outlook for Westpac. Ellis reduced his forecast average annual loan growth to 3.5 per cent, from 4.5 per cent, in response to tighter home lending criteria, switching from interest-only to principal and interest loans, and slowing demand for credit as the housing market cools.

However, Ellis emphasises he expects a housing prices to decline in an "orderly" fashion across Sydney, Melbourne, and Brisbane: "We do not expect a market crash".

He remains upbeat over the longer-term: "Westpac will benefit more than peers from a strong long-term earnings growth profile, superior operational efficiency, and impressive loan quality".

Westpac's fair value estimate was last reduced in July 2016, by around the same margin, in response to increasing global risks and tougher domestic regulatory demands.

 

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Glenn Freeman is senior editor at Morningstar Australia.

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