Australia | Sep 18 2006
By Chris Shaw
With market expectations in the US moving towards cuts in interest rates rather than further increases as part of the soft landing scenario for its economy the environment suits those stocks paying higher yields, of which the banks are an obvious example.
Not all banks are the same though, as the market reaction to last week’s earnings update for Westpac Banking Corporation (WBC), which saw the stock sold off by about 2%, shows. The update has raised concerns among the major brokers as to the outlook for the stock, particularly when compared to others in the sector.
Putting aside accounting issues such as the over-accrual in credit cards that will result in a write-down in earnings, the update provided most information on margins and revealed a decline that was larger than the market had been expecting. UBS regarded the update as a downgrade to forward forecasts and has reacted by further cutting its already bottom of the market earnings estimates.
It has lowered its forecasts by a further 2% after previously cutting forecasts by 3% in July, meaning its earnings per share estimates now stand at 162c for FY06 and 173c for FY07. These estimates compare to consensus forecasts of 167c and 182c respectively.
In its view there remains downside risk to FY07 forecasts as the bank is currently generating trading gains and margins that are unsustainable, so while the stock looks cheap against its peers it is justifiably so given the earnings outlook.
The broker rates the stock as Neutral 1 but notes it is the least preferred among the major banks, while following the update it has cut its price target to $23.00 from $23.50. ABN Amro has also reduced its target price to $23.53 from $23.83, its Hold rating based on the view the lack of detail as to why the margin decline was so severe is likely to overhang the share price until the details can be determined from the full year profit result due in a couple of months.
Its view is the margin decline is likely to reflect more aggressive pricing on products as the bank attempts to stem recent market share declines, so following cuts to forecasts of around 1.7% for FY06-FY08 it too rates the bank as the least preferred among the majors.
Deutsche Bank suggests the update reflects poorly on management as it contrasts to more bullish statements made at a strategy briefing in July, while operationally it is not impressed as the earnings guidance implies almost no growth in current half earnings compared with 1H06 despite strong system credit growth and low bad debt levels. In its view the aggressive pricing means there remains more work to be done in terms of fixing the problem of poor franchise performance.
Merrill Lynch agrees the update reflects badly on management, but the broker is sticking to its Buy rating and $25.90 price target. It notes the revised guidance was in line with its expectations and takes the view the margin decline is either temporary or cosmetic, in that the change reflects a shift in the bank’s financial markets income from net-interest income to non-interest income, implying it is not a true reflection of operating performance.
Like UBS it sees the bank as cheap but suggests investors use this as an opportunity, particularly as in its view there remains scope for further upside to dividends in future years. It is a view shared by GSJB Were, who while agreeing there is some short-term uncertainty sees potential upside for investors with a longer-term view. Merrill Lynch is more aggressive in its earnings estimates, forecasting earnings per share in FY06 of 166c, FY07 of 184c and FY08 of 198c compared to Weres at 164.4c, 176.2c and 190.1c.
The FN Arena database suggests the market overall is closer to the UBS view than the Merrill Lynch one, as the stock is rated Buy only three times compared to seven Hold/Neutral ratings, while the average share price target is $24.33.
Westpac shares today are lower in a flat market, as at 11.10am the stock was trading at $22.72, down 23c.