National Australia Bank (OTCPK:NABZY), Australia's fourth largest bank by market capitalization, has a fully franked dividend yield of about 6.5%. It may, however, be worth noting that the dividend has not been increased since 2014 and is likely to remain constant in the near term. Readers who have not yet read my article on CBA and the discussion of the Australian mortgage market contained therein (including the comments section) should ideally read that discussion in conjunction with this article.
Readers should take note thereof that all figures are referenced in AUD unless reference is made to the US ticker symbol or the contrary is indicated. It should further be noted that all comparisons made between the majors are based on Full Year 2016 earnings, which ended on the 30 th of September 2016 for all but CBA whose FY ended on the 30 th of June 2016, unless the contrary is indicated.
Asset Quality and Capital
The challenging environment for dairy farmers in New-Zealand has led to a deterioration in the quality of loans to this sector. National Australia Bank's (hereafter 'NAB') exposure to the dairy industry at NZ$8.43 billion is greater than that of Westpac Banking Corporation. The vast majority of this portfolio is, however, performing but with NZ$509 million on watch there is a risk of increased impairments in this portfolio. This risk has, as in the case of Westpac Banking Corp, become less pressing as the outlook for the dairy industry has improved.
The banks' exposure to developers in Australia, arguably the area where defaults are likely to be the highest in the event of a housing market collapse, at $8 billion is relatively low and does not give rise to substantial concerns. The bank is also aware of the increasing number of inner city apartments coming to the market in cities such as Brisbane and Melbourne and has capped its loans at a maximum loan to valuation ratio (LVR) of 80% in these areas. Many investors, and particularly the proponents of Australian Banks as candidates for a short, have expressed concerns over exposure to mining areas yet home loans to mining towns constitutes less than 1% of NAB's total housing portfolio. The bank has also capped the maximum LVRs in these areas at 70%. NAB's prudent lending practices should ensure that loan losses are more limited in the event of a housing market collapse- which I do not foresee.
NAB has the second highest CET1 capital adequacy ratio (on an APRA basis) of the four major Australian banks. The bank currently has a APRA CET1 capital ratio of 9.77% and an internationally comparable CET1 capital adequacy ratio of 14%. The bank's strong capital position reduces the probability of any dividend cuts.
Earnings and the safety of the dividend
NAB reported a 2 basis point decline in its net interest margin (NIM) which is higher than the 0.8 basis points average NIM decline reported by the majors as a group. The bank's cash profit after tax increased by 4.2% which is substantially better than the 2.5% average decline reported by the majors as a group and the highest increase by any of the four majors. It should, however, be noted that the bank's profit on a statutory basis, which includes non-recurring items, was the lowest of all four majors.
The bank's cost to income ratio increased by 20 basis points which is lower than the 116 basis point average increase for the majors as a group. The bank's ROE on a cash basis declined by 50 basis points representing the lowest decline in cash ROE of the four majors and well below the average decline in ROE of 194 basis points for the majors as a group. The bank's ROE is, much like the ROE for the other majors, likely to decline further in 2017 but should remain within range.
The bank's current payout ratio is extremely high as a result of the substantial drop in statutory profit but the payout ratio on free cash flow at 84% is more sustainable. This does, however, remain high and leaves limited room for future dividend increases without earnings growth. In this regard the bank's superior cash profit increase should be considered but is unlikely to lead to an increased dividend as Australian banks have increased their focus on capital levels. I do not, however, foresee a cut in the current dividend in the near term.
Valuation and Conclusion
The stock is currently trading at about 1.6 times book value which is slightly below its 5-year average of 1.63. The lower price to book value is in my view, as in the case of the other majors, the natural consequence of a lower ROE. The stock is trading at a p/e ratio of 12.64 which is below its 5-year average p/e ratio of 14.06 and lower than that of its peers such as Westpac Banking Corp. trading at a p/e ratio of 14.91 and CBA trading at a p/e ratio of 15.2.
I currently consider the stock more attractive from a valuation point than some of its peers and foresee that the dividend will remain stable in the near term. The bank's asset quality also remains high but seems weaker than that of some of its peers considering that it has the second highest level of impaired loans as a percentage of loans amongst the four majors. Its higher exposure to the dairy industry in New Zealand also exposes it to more risk than the risk to peers such as Westpac Banking Corp.
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