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Westpac Banking Corp. Continues To Perform Well

|About: Westpac Banking Corporation (WBK)

Westpac Banking Corp. (WBK) is expected to offer a fully franked dividend yield in the region of 6% in 2018. The more hostile political environment which I warned of earlier this year has, however, persisted to some extent with several Australian State’s attempting to introduce a banking levy similar to that introduced at the national level earlier in the year.

It does, however, seem that the banks have been able to pass some of the costs of the levy on to customers and the passing of a banking levy has failed in at least one state. The strong opposition mounted against the State level banking levy in South Australia also reduces the risk of other State’s moving forward with the introduction of such levies. Readers should take note thereof that all figures are referenced in AUD and that all capital figures referenced are on a Basel III basis as adopted by APRA unless the contrary is indicated. It may also be worth noting that the reference to WBC contained in this article is the Australian ticker symbol for WBK.

Asset Quality and Capital

WBC has a Capital Adequacy Ratio (CAR) of 14.8% which is the second highest of the four biggest Australian banks (hereafter referred to as “the majors”). It also represents 80-basis points increase in its CAR from the time of its half-year results at which time its CAR was the second lowest of the majors.

(Source: Company Fillings)

WBC’s Common Equity Tier-1(CET1) CAR at around 10.6% is also, along with that of Australia & New-Zealand Banking Group (OTCPK:ANZBY), the highest of the majors. This represented a significant improvement from the 10% reported earlier this year at the time of its half-year results. The bank’s focus on improving capital ratios is also likely to persist in the near term as the bank works towards the Australian Prudential Regulatory Authority’s (APRA) requirement of “unquestionably strong” capital levels.

(Source: Company Fillings)

WBC’s Gross Impaired Loans as a Percentage of Total Loans and Advances at 0.22% is also the lowest of the majors. This represented a further 8-basis point decline from its half-year results in its impaired loans ratio and ensured that the bank maintains its long-held leadership position in the lowest level of impaired loans.

(Source: Company Fillings & KPMG)

The majors as a group also reported a 15.2% decrease in impaired assets and a 23% decline in provisioning expenses which showcases the relatively strong asset quality of the Australian banks despite some concerns over a housing bubble.

Earnings and the Dividend

WBC reported a Net Interest Margin (NIM) of 209 basis points for the full-year of 2017. This is the second highest NIM for the majors and represented a 4-basis point YoY decline which is broadly in line with the 5-basis point decline in the average NIM for the majors as a group. The bank’s NIM also seems unlikely to increase in the near future for as KPMG correctly noted:

“In the first half of the year, competition for customer deposits and the impact of the Major Bank Levy in the final quarter of 2017 combined with lower earnings on capital have offset mortgage repricing efforts.

The banking levy is also expected to place further downward pressure on the majors NIM as it takes full effect in 2018 whilst the Reserve Bank of Australia is likely to approach rate hikes with caution in light of the relatively high household debt-disposable income ratio.

(Source: Company Fillings)

WBC reported a 2.3% YoY increase in Net Interest Income (NYSEMKT:NII) for 2017 which was the second highest increase in NII of the majors. The growth in NII will, however, likely remain low for the foreseeable future considering the low cash rate, slowing asset growth and weaker loan demand. The demand for loans is likely to remain low in the near future as underemployment and weak wage growth dampens economic growth and in turn loan demand.

WBC’s non-interest income declined by 1% YoY as the increase in trading and operating lease income was more than offset by declines in fees and commissions as well as declining insurance income resulting from an increase in claims. The bank’s non-interest income may show some signs of recovery in 2018 but may merit closer attention from investors in the near term.

WBC is expected to yield 6.03% fully-franked in 2018 which is the second highest of the majors. It is worth noting that a US investor will not pay any dividend withholding tax on a fully-franked dividend.

(Source: Reuters)

WBC’s expected payout ratio at 78.2% is, however, the second highest of the majors and increases the risk of a dividend cut. The bank’s relatively strong capital position is nevertheless supportive and somewhat justifies its higher payout ratio.

(Source: Simplywall.st)

WBC has also remained cost conscience as its Cost to Income ratio at 42.2% on a cash basis remained the lowest of the majors. It did, however, increase by 10-basis points which does not in itself give rise to substantial concern particularly when factoring in increased costs of compliance with government regulation.

(Source: Company Fillings)

The majors Return on Equity (ROE) has been under pressure in recent years as the banks faced a low-interest rate environment and set aside increased regulatory capital. WBC is, nevertheless, expected to deliver a 13.8% ROE in 2018 which is the second highest of the majors and in line with its cash basis ROE for 2017.

 

(Source: Reuters)

The potential of a decrease in its ROE for 2018 is, however, more likely than an increase. This is as the risk of State-wide banking levy’s being introduced remains despite a decrease in such risks after a proposed State-wide banking levy was blocked in South Australia. The risk of the Federal Government not raising as much revenue as it expected from the banking levy also increases the risk of the levy being increased although such increase is unlikely in 2018.

Valuation and Conclusion

WBC is trading at 13 times expected earnings for 2018 which is the second lowest of the majors. It is also slightly below its 5-year average forward P/E ratio which is in the region of 13.3.

(Source: Reuters)

Its forward Price to Book value at 1.69 is the second highest of the majors and broadly in line with its 5-year average P/B ratio. Its higher-than-peers forward P/B ratio can, however, in my view be justified by its higher-than-peers expected ROE.

(Source: Reuters)

I currently favor WBC over the other majors in light of its strong asset quality and reasonable valuation. The risks of an increasingly hostile political environment and the weaker economic outlook for Australia has not, however, subsided entirely. Investors should thus remain cognizant of these risks and not simply be lured in by the dividend yield.

Take note thereof that except for the chart from Simplywall.st all charts were created by the author. The source indicated at the bottom of the charts is, therefore, the source of the underlying data.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.