National Australia Bank: Keeping the momentum going

Author name:: By Nathan Lead
Job title:: Senior Analyst
Date posted:: 10 November 2022, 7:00 AM
Sectors Covered:: Infrastructure, Utilities, Banks

National Australia Bank's (ASX:NAB) FY22 result was below our forecast but in-line with consensus.
Key outlook items include a rising net interest margin, higher costs, and increasingly cautious rhetoric on the future credit risk environment.
HOLD retained. Target price increased (login to view). At current prices, we expect 5.5% cash yield (c.8% including franking) across the next 12 months.

Event

NAB published its FY22 result, with growth in pre-provision operating profit (+6% growth in 2H22) greater than cash earnings (+4%) due to rising albeit minimal loan loss expensing.

However, reduced shares due to the buyback meant cash EPS rose 6%. 2H22 DPS of 78 cps (fully franked) was 5 cps above 1H22.

Analysis

Net interest income delivered c.81% of revenue and grew 10% in 2H22, with interest earning assets growing c.6% (from both loan growth and increase in liquid assets) and the NIM expanding 4 bps. 4Q22 NIM was 172 bps vs Q3 of 162 bps, below the 180bps we were targeting but on an upward trajectory into FY23. We now assume the NIM peaks in 2H23F at 187bps, before fading over time as home loan competition, deposit mix and cost pressures offset the rising returns on the deposit and low rate replicating portfolios.

Upward pressure on opex (+9% in 2H22) is outpacing the productivity benefits being achieved ($465m in FY22, c.$0.3bn in 2H22). We assume opex lifts c.13% in FY23, given wage and headcount growth, vendor cost inflation, higher investment spend, higher D&A, and additional costs from the AUSTRAC EU and Citi acquisition exceeding NAB’s $400m productivity benefit target for FY23.

The releasing of credit loss provisions that benefitted earnings in FY21 has reversed, with 4 bps of gross loans expensed in 2H22. NAB believes it has provisioned appropriately against difficult economic scenarios (45% weighted to its downside scenario that includes >30% decline in house prices and 8.5-10% unemployment across FY23-25). However, we assume that loan loss expensing ramps up to a long-run loan loss rate of 21 bps by FY24, resulting in a c.$1.4bn headwind to earnings growth.

NAB indicated that its proforma CET1 ratio was c.11.8%, with a further c.45bps expected to be added over FY23-24 from unwind of interest rate impacts. Against a target CET1 ratio of 11-11.5%, this offers opportunity for c.$3bn of share buybacks to release the surplus capital.

Return on Equity (ROE) lifted 1% to 11.7% in FY22, and was 12.1% in 2H22. We forecast ROE rising to c.13% in FY23, as a result of earnings growth and cash returns to investors. The ROE is above our estimate of NAB’s cost of equity which, along with NAB’s growth, justifies a trading premium to book value as well as a premium to ANZ and WBC (who are generating lower ROEs).

Forecast and valuation update

Material downgrade to FY23F as we factor in lower NIM leverage and higher costs. Higher costs also cause a milder downgrade to FY24F. We upgrade FY25F by 6% as we assume the NIM plateaus at a higher level than previously.

We forecast c.20% growth in pre-provision operating profit in FY23F and 5% in FY24F. The ramp-up in loan provision expensing offsets this growth, such that cash earnings lift by c.16% in FY23F and are flat in FY24F. Buybacks mildly enhance this growth on an EPS basis.

DCF-based 12 month target price lifted (login to view). Our TP implies c.1.5x P:BV (end-FY23F) and c.12x PER (FY24F), while we think the current share price implies c.1.7x P:BV (end-FY22A) and c.12x PER (FY23F).

Price catalysts

Q1 trading update in mid-February. Key economic data releases and RBA policy cash rate changes. Monthly APRA and RBA lending and deposit balance and interest rate data releases.

Risks

Interest, and inflation, and foreign exchange rates.
Credit risk (key considerations being unemployment and value of collateral).
Competition for loans and deposits.
Regulatory risk.
Liquidity and funding risk.
Cybersecurity.

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