Westpac Banking Corp: Rising NIM, rising FY24 cost target

About the author:

Nathan Lead
Author name:
By Nathan Lead
Job title:
Senior Analyst
Date posted:
08 November 2022, 8:30 AM
Sectors Covered:
Infrastructure, Utilities, Banks

  • We viewed Westpac Banking Corp's (ASX:WBC) FY22 performance as at or above expectations.
  • The interest rate leverage in the Net Interest Margin (NIM) was the key positive, while the key negative (but not unexpected) was the upsized FY24 cost guidance.
  • Even after forecast earnings and target price downgrades (login to view), we think the return/risk trade-off is sufficiently attractive to justify an ADD rating at current prices. 12-month potential return c.20%, 5 year IRR >10% pa.

Event

FY22 was distorted by $1.3bn of pre-disclosed notable items. Excluding these items, pre-provision operating profit and cash EPS lifted 12% in 2H22. The 2H22 DPS of 64 cps (f/franked) was 3 cps ahead of expectations.

Analysis

Net interest income delivered c.84% of revenue and grew 7% in 2H22 (+c.3% growth in asset base, 5 bps increase in NIM to 190 bps). The NIM (excluding Treasury & Markets NIM which is typically 10-15 bps) exited 2H22 at 185 bps.

We assume the NIM peaks in 2H23 at 215 bps (higher rates continuing to benefit earnings on deposits and hedge portfolios, roll-off of lower margin fixed rate loans) before fading over time (intense competition, deposit mix, funding cost pressures).

WBC is targeting 1H23 loan growth around major bank system growth, with the broader system expected to slow. We model loan growth slowing to 2-3% across FY23-24F due to the long and variable lag impact of the RBA’s cash rate increases.

The FY24 cost target has been revised to $8.6bn from $8bn, with WBC noting higher inflation, later timing of business exits, and longer phasing of regulatory costs since the initial target was set. We have added more conservatism to our forecast by factoring in higher costs for items excluded from the target, so that our FY24F cost target is c.$9.6bn. 

Expected credit loss (ECL) expensing continued to be low (5 bps of gross loans). WBC highlighted the improvement in asset quality and the strength of its ECL provisioning (above both pre-COVID levels and its base case provisioning that assumes significant economic weakening). We continue to conservatively assume upward normalisation of ECL expensing to 17 bps by FY24.

Return on average book equity (ROE) was 7.4% (9.8% exc. notable items), which is below what we estimate to be WBC’s cost of equity. We expect ROE to rise into the low double digits in FY23 as earnings grow faster than capital requirements.

The Common Equity Tier 1 Capital Ratio exited 2H22 at 11.3% compared to a 2023+ operating target of 11-11.5%. We forecast no buybacks in FY23F, but can see surplus capital building that may allow c.$6bn of buybacks across FY24-25F.

Forecast and valuation update

c.2-8% downgrades to FY23-25F cash EPS as result of downgraded NIM and non-interest income and higher costs. DPS downgraded further than EPS as we apply a lower payout ratio within the target range given increasing economic uncertainty.

Normalising for FY22’s notable items, we expect cash EPS to grow 26% (NIM expansion, declining costs) and 4% in FY23/24F (rising ECL expensing). We target FY23 DPS of $1.53/sh, implying 6.6% yield at current prices (9.4% incl. franking).

12-month target price reduces (login to view). Our TP implies c.1.2x P:BV (end-FY23F) and c.11x PER (FY24F), while we think the current share price implies c.1.2x P:BV (end-FY22A) and c.10x PER (FY23F).

Price catalysts

Q1 trading update likely early Feb-23. Key economic data releases and RBA policy cash rate changes. Monthly APRA and RBA lending and deposit balance and interest rate data releases.

Disclosure of revised capital ratios arising from APRA’s revised capital adequacy framework. M&A events.

Risks

Interest, 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. Achievement of cost-out targets and completion of Specialist Businesses exits. Cybersecurity.

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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.

     


     

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