Westpac Banking Corp: Buyback and medium-term cost story the highlights

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Former Senior Analyst
Date posted:
26 October 2021, 8:00 AM
Sectors Covered:

  • Westpac Banking Corp (ASX:WBC) is scheduled to report its FY21 result on 1 November 2021. We are forecasting cash earnings of $5,237m.
  • In the aftermath of WBC’s announcement of $1.3bn of notable items for 2H21, we very conservatively reduced our final dividend forecast from 54cps to 30cps due to uncertainty as to whether notable items will be excluded by WBC in determining the final dividend.
  • While WBC did not appear to exclude notable items in determining the interim dividend, we realistically expect WBC to look through the notable items this time around as ~$1bn of the notable items relate to write-downs of intangible assets. We have consequently increased our final dividend forecast to 50cps fully franked.
  • We continue to expect a $5bn off-market share buyback to be announced.

Looking for home loan growth to be in line with system

APRA data shows that WBC grew its Australian home lending by 3.0% from Mar-21 to Aug-21, in line with system growth. Within WBC’s Australian home lending, APRA data shows growth of 6.5% in owner-occupier lending and a 1.5% contraction in investor lending.

This shift in composition of WBC’s Australian home lending towards owner occupier should be comforting to investors as it arguably de-risks WBC’s Australian home lending book and this shift in composition will likely be rewarded by APRA’s proposed new risk weighted asset framework.

Expecting relative NIM advantage from shorter duration hedges

We are forecasting NIM contraction of 3bps from 1H21 to 2H21 partly due to a NIM drag from Treasury & Markets in 2H21. Excluding Treasury and Markets, we expect the key NIM headwind to be related to the home loan front to back book margin differential as well as the impact of customer switching from variable to fixed rate.

APRA data pleasingly shows growth of ~4% in Australian customer deposits from Mar-21 to Aug-21. We expect a favourable shift in funding mix as a result of strong growth in low-cost deposits relative to group loan growth.

In 1H21, WBC’s NIM was the beneficiary of a largely tailwind of 6bps from deposit repricing. Whilst we expect this deposit repricing benefit to flow through to 2H21, we expect this tailwind to be a more modest 3bps in 2H21.

We expect a reduction in the average cost of wholesale funding for WBC from 1H21 to 2H21 as a result of TFF drawdowns and maturing term debt.

We expect WBC to be a greater beneficiary of rising swap rates through its replicating portfolio as its hedges sit more towards the short end of the swap curve. It is our understanding that at last report the duration of WBC’s replicating portfolio for low-cost deposits was 3 years and the duration for the capital hedge was 1 year.

The 3-year swap rate increased by ~19bps over 2H21 whereas the 5-year swap rate increased by ~11bps over the same period. With its shorter duration of hedges relative to peers, we also expect WBC to be able to take quicker advantage of the notable jump in 3-year and 5-year swap rates of ~38bps seen this month.

FY24 cost base target is exciting

While WBC managed to keep its underlying costs flat from 2H20 to 1H21, we are expecting a 7% increase in underlying costs from 1H21 to 2H21 largely due to increased investment spend.

However, the exciting part on costs is the medium-term story with WBC looking to reduce its underlying cost base from $10.2bn in FY20 to $8bn by FY24.

As WBC moves closer to achieving its $8bn annual cost base target, we expect WBC’s cash ROTE to move towards 16% and we expect the P/NTA multiple to move towards 2.1x compared with our FY23F P/NTA multiple of 1.5x.

Expecting sound underlying credit quality trends

We are forecasting a credit impairment charge of $330m for 2H21, $300m of which relates to the individual provision charge taken by WBC in the Jun-21 quarter in relation to the Forum Finance alleged fraud.

Investment view and changes to forecasts

We have not materially changed our cash EPS forecasts.

Our target price, based on our DDM valuation, is unchanged at (login to view).

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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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