Banks: The value-trap trap

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Senior Analyst
Date posted:
06 December 2021, 7:30 AM
Sectors Covered:
Banks

  • We have an overweight stance on the major banks sector. We continue to believe that balance sheet strength, robust dividend yields, potential for further capital management and improving cost efficiency over the medium term are the key reasons to be invested in the sector.
  • In the absence of material asset quality deterioration, we expect a rising interest rate environment to be supportive of major bank earnings.
  • Westpac (ASX:WBC) is our preferred major bank. While WBC stock is now being priced like it is a value trap, we do not believe it is a value trap and we explain our views on this front in detail in this report.

Not seeing WBC as a value trap

WBC shares have been sold off heavily following the FY21 result announcement, such that out of the major banks, WBC is now trading on the lowest FY22F P/NTA multiple, the lowest FY22F P/E multiple and the highest FY22F dividend yield. Such multiples or yields could only be justified if WBC is a value trap, which we think it is not.

We believe the challenges facing WBC are not severe enough for WBC to be thought of as a value trap. The two key sources of investor consternation in relation to WBC appear to be: net interest margin (NIM) contraction; and risks to achieving the $8bn cost target by FY24F.

On the NIM front, we believe the challenge facing WBC is not too different to the NIM challenge facing CBA. It is difficult to do a like-for-like comparison of ANZ’s recent NIM movement with that of the other major banks given that ANZ’s home loan book has been shrinking.

However, what has made the NIM of WBC and CBA look particularly bad is the stable NIM (excluding Markets & Treasury) reported by NAB. In this report, we discuss the factors driving WBC’s NIM underperformance relative to NAB in 2H21, and we point out our view that these factors of underperformance are very much addressable.

What’s in the WBC share price?

One way for us to arrive at a valuation – predicated on a cost of equity of 9% pa – which matches WBC’s current share price of ~$20.50 would be to assume that WBC only manages to reduce its annual cost base to $9.5bn by FY24F (compared with an underlying cost base of $10.2bn in FY20), experiences NIM contraction of 50bps from 2H21 to 2H24F and conducts no further capital management with all other elements of our forecasts unchanged.

As we discuss inside this report, we expect WBC to do notably better than this and we consequently believe that the extent of pessimism being reflected in WBC’s current share price is overdone.

Sector themes aren’t unnerving

Thematically, the only notable negative to point out is intense mortgage competition. Having said this, mortgage competition and low interest rates have been the two key NIM headwinds for the last three years and the banks have generally managed group NIMs well with these two headwinds in place.

With the low interest rate headwind now having played out in our view, we see the banks as only having one notable NIM headwind with which to contend. We believe there are enough tailwinds in place to largely offset this headwind.

These tailwinds include: strong growth in low-cost deposits; using funding drawn on the RBA’s Term Funding Facility (TFF) to replace maturing term wholesale funding; Markets & Treasury tailwinds; and signs that borrower demand for fixed rate home loans may have peaked.

Overall, we view dividend yields as robust and we continue to see this as the key reason for being invested in the sector.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.


Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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