Westpac results: Positive momentum but cost savings still a medium-term story
Our view after the shares have appreciated over 42% in the last year.
Mentioned: Westpac Banking Corp (WBC)
Westpac’s WBC third-quarter 2024 update was a little better than we expected, prompting a 3% upgrade to our fiscal 2024 profit forecast but no change to our $28 fair value estimate. Operating and bad debt expenses are both tracking a little lower than we anticipated, but neither affects our long-term view.
Net interest margin ("NIM") up 3 basis points on the first half to 1.92% is a welcome sight. While competitive pressures remain, discounting to attract borrowers has eased over the last 12 months. We expect modest NIM improvement from here, as margins and returns for smaller banks are still weak. Westpac is restoring confidence it can compete effectively across all key segments, growing home loans, business loans, and deposits, in line with or faster than market without undercutting peers on price.
Operating expenses increased 2%, and we forecast fiscal 2024 expenses to rise 4% year on year. Our forecasts assume below-inflation cost growth over the next five years. This is driven by Westpac reducing headcount, consolidating systems, office space, and branches, and as customer remediation and risk and compliance projects complete. Digitizing more of the loan application and approval process should also help.
Wide-moat Westpac shares are modestly overvalued at current prices. We think the share price reflects our view the bank is past regulatory and operating issues and is now well-placed to grow revenue in line with peers and simultaneously achieve operating cost savings. Westpac trades on a reasonable fiscal 2025 P/E of 14 times and fully franked dividend yield below 5.5%.
Westpac remains well-capitalized. Common equity Tier 1 ratio of 12% comfortably exceeds regulatory requirements, and its 11%-11.5% target. We think the balance sheet—excess capital and loan loss provisions—and household balance sheets—equity and saving buffers—leave the bank in a good position to cope with a potential increase in borrower defaults.
Business strategy and outlook
Westpac Bank is the second-largest of Australia’s four major banks. The bank provides a range of banking and financial services to retail and business customers, including mortgages, consumer finance, credit cards, business loans, and term deposits. Most nonbanking units have been divested, including general, life, and mortgage insurance.
Westpac's multibrand strategy owes to acquisitions, such as St. George Bank in 2008, to provide access to a broader customer base and add scale. Only recently has Westpac began colocating branches and building IT systems which allow any customer to be served in any branch. A focus on digital channels to improve the customer experience are required to remain competitive, and have the potential to lower the cost base.
While risks directly related to coronavirus have abated, wage pressures, labor, and supply chain challenges, and high inflation pose challenges as the cash rate increases. The main current influences on earnings growth are modest credit growth and intense competition limiting margin upside from a higher cash-rate environment. Operating expenses should rise modestly as the bank resets its cost base after completing a number of remediation and technology projects. The bank has suffered from slow approval times in home lending, but expects increased resources and digital investments to improve service levels.
After enjoying super-low impairment charges pre-2020, we expect a return to midcycle levels around 0.17% in fiscal 2027. There is a risk of higher losses in the short term as households and business face a material increase in interest costs, but our base case is that only a small percentage will default.
Westpac bulls say
- A higher cash rate environment gives customer deposit funding banks an opportunity to expand margins and drive higher return on equity.
- Cost and capital advantages over regional banks and neo-banks provide a platform to win back market share.
- Consumer banking provides earnings diversity to complement the more volatile returns generated from business and wholesale banking activities.
Westpac bears say
- Slow core earnings growth resurfaces because of low loan growth, margin compression, subdued wealth and markets income, lower banking fee income.
- Increasing pressure on stressed global credit markets could increase wholesale funding costs.
- The bank failing to reset the cost base would leave it at a large disadvantage to peers when it comes to operating efficiency and ROE.
