Australia | Nov 02 2018
As issues surrounding Australian housing credit growth and tightening lending standards continue to dog the banks, National Australia Bank's FY18 results indicate a weighting to the commercial sector stands it in good stead.
-Challenging capital position and uncertain divestment strategy are potential risks
-Leveraged to an improving business credit environment
-Can NAB narrow its historical gap to peers?
By Eva Brocklehurst
A focus on business banking is likely to help National Australia Bank ((NAB)) narrow the gap to its peers, as the industry endures the slowing of Australian mortgage growth. The bank reported cash earnings of $5.7bn in FY18 and an unchanged final dividend of $0.99.
Issues regarding the slowdown in Australian housing credit growth and tighter serviceability requirements continue to dog the banks, but brokers believe this result should serve to alleviate some concerns.
Momentum in commercial banking means NAB is well placed, in Citi's view, as the implications of the Hayne Royal Commission continue to emerge. Now is a good time to be a commercially-oriented bank, the broker asserts, and NAB's outperformance is likely to be determined by continued execution on its restructuring plans.
Citi believes the current share price offers good risk/reward amid restructuring benefits. However, a challenging capital position and a divestment strategy regarding MLC could be potential risks, the broker concedes.
This was one aspect that displeased Credit Suisse, as uncertainty continues regarding the benefits from divesting MLC and the impact on the dividend. Still, in a deeply-discounted sector delivering a result that is in line with expectations is considered acceptable.
Macquarie recognises significant restructuring carries risks of disruption but, to date, this has not had a material impact on the bank's momentum. If NAB can maintain its performance in FY19, the broker suspects revenue trends should be in line or potentially ahead of peers.
Ord Minnett finds it hard to become excited about the minor underlying revenue growth in the second half, although better revenue trends are expected to become more apparent once the bank reporting season is completed.
The broker believes the valuation is compelling, as the stock is trading at around 11x FY19 forecast earnings. Ord Minnett's Accumulate rating reflects the banks tilt to small business banking, which provides leverage to an improving business credit growth environment and insulates it from the pressures in retail banking.
Morgan Stanley believes the outlook is uncertain and there is an increased probability of weaker revenue growth and a rise in impairment charges. As there is little margin for error on costs, capital or the dividend the broker maintains an Underweight rating. Moreover, a reduction in major bank profitability may be required over the next few years to win back the support of key stakeholders.
Net interest margin in FY18 was assisted by a five-basis-points improvement in New Zealand and a stable institutional margin. Morgans commends the bank's margin management and discipline, which has meant NAB did not need to increase its variable home loan rates in Australia, unlike other majors.
Loan growth was strong in small-medium enterprises, institutional banking and New Zealand, which the broker considers are significant drivers in the face of slowing home loan system growth in Australia.
Credit Suisse is pleased the result met expectations at a headline level. Yet, the decision not to re-price mortgages potentially leaves the bank at a disadvantage for revenue in the short term, which the broker expects will manifest in an inferior margin outcome in the first half.
Macquarie agrees the main risk is potential underperformance on margins, if management decides not to follow its peers in re-pricing mortgages. However, the broker suspects the bank will eventually re-price mortgages, probably in January, and that would provide $145m in benefits in FY19.
Furthermore, a decision on mortgage re-pricing will be the key risk to the bank's ability to outperform peers and Macquarie expects NAB will rely on a dilutive discounted distribution reinvestment plan to support its capital position, or it will need to cut its dividend. The bank's credit quality may be sound and arguably better than peers but Macquarie suggests the capital position is at the bottom of the peer group.
Morgan Stanley notes the CEO, Andrew Thorburn, has indicated that variable mortgage rates are only on hold "for now", and he acknowledged that banks need to reconsider the practice of re-pricing the back book and discounting the front book. Morgan Stanley believes this weighs on the outlook for near-term revenue growth and medium-term retail bank profitability.
On the other hand, Ord Minnett asserts, an improved capital position and supportive valuation would mean the bank can narrow its historical valuation gap to peers.
FNArena's database has five Buy ratings, one Hold (Credit Suisse) and two Sell. The consensus target is $29.31, suggesting 17.1% upside to the last share price. The dividend yield on FY19 and FY20 forecasts is 7.7% and 7.6% respectively.
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