How Will Westpac’s Latest Acquisition Affect Dividends?

This story features WESTPAC BANKING CORPORATION, and other companies. For more info SHARE ANALYSIS: WBC

-Modest earnings increase
-Still room for special dividend
-Logical acquisition for Westpac
-Synergies with St.George business
 

By Eva Brocklehurst

Westpac Banking Corp ((WBC)) has tucked away an acquisition at a cost of $1.45 billion. Despite what some brokers consider is a pricey ticket, most think the bank should still have plenty of capital left over to dole out a special dividend when it posts FY13 results in November.

The acquisition involves the UK bankLloyds' motor and equipment finance business, Capital Finance Australia, as well as the corporate loan portfolio, BOS International, as Lloyds exits Australia. The loan book comprises $3.9bn in motor vehicle finance, $2.9bn in equipment finance and $1.6bn in corporate loans. The bank will also pay $100m for market value of related interest rate swaps.

BA-Merrill Lynch is of the view that incremental earnings from the acquisition will go hand in hand with further capital management. The broker raised earnings forecasts by 1-2% for FY14-16 to reflect the deal and also expects a 10c per share, second half FY13 special dividend. While such a deployment of capital is considered sensible, Merrills does not find Westpac's valuation compelling and retains a Neutral rating. The assets in the acquisition represent less than 2% of Westpac's first half gross loans, suggesting to Merrills that risks are not excessive. The broker, after adjusting for the pro forma 38 basis points impact of the acquisition on the bank's tier 1 ratio, believes Westpac can still pay that special dividend and stay at the top end of its 8-8.5% tier 1 target range. The bank reported an 8.4% tier 1 ratio in the June quarter and should be nearing 9% for the FY13 result.

Westpac's valuation is full, in CIMB's view, and deserving of an Underperform rating. This broker suspects the 38 basis point impact on the tier 1 ratio actually removes a capital edge at a time when the banks may need to boost capital ratios. Although Westpac did not provide a split, the asset finance unit likely accounted for the vast majority of the price paid. CIMB calculates the cost of the deal equates to 1.2 times net tangible assets and a price/earnings ratio of about 22 times, on the assumption that the cost of the institutional book was $100m and the asset finance business can reach $60m net profit in FY14. This is high relative to similar deals in the past decade but, the broker concedes, as takeover opportunities are scarce, comparisons are a little hard to make.

CIMB has added a filip to profit forecasts because of the small margin boost from the bank's increased weight in the higher-spread personal and small business car finance lending as well as an expected $70m in cost synergies by FY15. It's just that the broker has a niggling concern about weakening the balance sheet relative to peers, especially on capital. As the bank already lags peers on deposit funding and could fall further behind, CIMB thinks there's some risk that retail deposits will need to be priced more aggressively.

One thing the deal does is reduce the likelihood the bank will look for acquisitions in Asia in the medium term. There had been speculation since Westpac bid for a stake in Bank of East Asia in late 2012. Citi thinks Westpac is the most logical acquirer of the asset suite as ANZ Bank ((ANZ)) is more focused on expansion into Asia and its Esanda unit is already the largest equipment and motor vehicle dealer finance provider. Commonwealth Bank ((CBA)) does not appear to be chasing this market and the broker suspects Macquarie Group ((MQG)) was most likely outbid because of higher funding costs, higher cost of capital and lower strategic importance.

The capital position doesn't bother Citi. The broker retains forecasts for the 10c special dividend and dividend reinvestment plan (DRP) neutralisation. The broker sees few integration risks. Lloyds supported these businesses after the GFC and had telegraphed the sale process well. Moreover, considerable economies of scale can be achieved through Westpac's St.George equipment and motor vehicle financing network. While the purchase is not conditional on ACCC approval, the consumer watchdog may take a look at the vehicle dealer floor plan share, which is already highly concentrated. As these loans account for less than 10% of the acquisition, even if divestment is forced on Westpac it should not reduce the benefits, in Citi's view.

JP Morgan agrees that, as an established player in the financing market through St.George, Westpac is well able to extract synergies for the lease books relative to Commonwealth Bank or National Australia Bank ((NAB)) while ANZ's Esanda business may have presented issues for ACCC, if ANZ had set its sights on the business. JP Morgan observes that the portfolio should return over 12% without any benefits ascribed to revenue synergies or cross selling. Moreover, it underpins the bank's capital management policy of a steady increase in dividends and an increase of 2c per half is still expected.

Given the returns are above cost of equity, JP Morgan prefers this way of deploying excess capital, noting the market was less than enthusiastic about the first half FY13 special dividend. Westpac has generated sufficient organic capital to fund incremental growth in the mortgage business and so this particular acquisitions does not hold an "opportunity cost" relative to other ways of deploying capital.

Westpac has made an incremental acquisition without compromising other capital management initiatives, according to Credit Suisse, which assumes a special dividend of 10c for the next three and a half years, as well as DRP buy-backs. The broker considers the acquisition manageable but not transforming for the bank and retains an Underperform rating. 

On FNArena's database Westpac has four Buy ratings, two Hold and two Sell. The consensus dividend yield on FY13 and FY14 earnings estimates is 5.7%. The consensus target price is $32.38, suggesting 1.6% downside to the last share price, and this has moved up from $31.77 ahead of the acquisition announcement. The price targets range from $28.50 to $36.16.
 

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