National Australia Bank's NAB first-quarter profit of $1.74 billion slipped 2% on last year, the key driver being higher loan impairment expenses. Loan growth was largely offset by softer net interest margins, but the bank still managed to increase the top line by more than operating expenses.  

Why it matters: The bank is tracking in line with our 3.5% profit growth forecast for the full year. Rising loan impairments are not alarming, as it is off a very low base. We estimate the first-quarter number equates to 0.14% of loans, below our medium-term forecast of around 0.20%.

  • The bank expanded its home and business loan books by 1% and 2% in the quarter, slower than 1.6% and 2.2% for the market. Over the medium term, we expect some easing in term deposit and saving account pricing to help the bank lift NIM modestly, while increasing loans in line with the market.
  • With fierce competition, management must keep expenses down while investing for the future. Underinvestment can hurt for years. Management reiterated vague expense growth guidance to be lower than last year's 4.5% and this appears to be tracking in line with our 4% forecast.

The bottom line: Our $32 fair value estimate on wide-moat National Australian Bank is maintained. An average return on equity of 12% over the past three years speaks to the bank's quality. However, on a forward P/E of 16.5 times and a dividend yield of 4.5%, we think shares are overvalued.

Between the lines: National Australia Bank remains well-capitalized, with a common equity Tier 1 ratio of 11.6% supporting our dividend forecasts and assisting in coping with any larger-than-expected rise in credit stress.

  • Impaired assets/loans was steady in the quarter, but nonperforming exposures/loans edged up by 4 basis points. Higher cash rates have gradually eroded the savings of some customers, having faced higher finance costs and, in some sectors, lower demand.

Business strategy and results

National Australia Bank is one of four major banks operating in oligopolistic Australia and New Zealand markets. It is Australia's biggest business bank, offering a full range of banking and financial services to the consumer, small business, and corporate sectors, with significant operations in New Zealand.

The bank has consistently held onto its large share of business loans, and continued investment shows a clear intention to retain this position. The banks greater investment into specialist credit teams across areas such as agriculture, health, education, franchising, as well as business banking centers, sets the bank apart. This ultimately gives the bank a better understanding of the customers’ requirements, faster turnaround times, and higher approval rates. Capacity to make investments into digital onboarding and fast access to unsecured lending ensure the bank retains high satisfaction amongst small business customers.

The main current influences on earnings growth are modest credit growth, stable margins as the banks adjust prices to a higher cash rate environment, and investments in digital offerings. Operating expenses will continue to rise as the bank invests to capture growth opportunities, this despite productivity improvements being realized.

We expect a return to midcycle levels around 0.20% in fiscal 2028. High levels of bad debt provisions expected to help buffer the earnings impact of rising impairments in the short term, and could even be a positive for earnings if released.

NAB bulls say

  • Management focus is on the successful, lower-risk, and profitable domestic banking. Economies of scale, pricing power, a strong balance sheet, and high credit ratings provide a robust platform to drive growth.
  • As Australia's biggest business bank, National Australia Bank has the most to gain from strong demand for business credit.
  • NAB has the ability to achieve cost savings and drive operational efficiency improvements

NAB bears say

  • A slowdown in core earnings growth could come from slower business loan growth, margin compression, falling fee income, and a worse-than-expected loan loss outcome.
  • If stress returns to global credit markets wholesale funding costs could increase materially.
  • Regulatory, compliance, remediation, and customer refund risk are difficult to predict.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.