Analysts Remain Wary Of NAB

This story features NATIONAL AUSTRALIA BANK LIMITED, and other companies. For more info SHARE ANALYSIS: NAB

– NAB's profit result low quality
– UK continues to drag
– analysts worried about mining exposure
– How safe are dividends?
 

By Greg Peel

“We continue to expect NAB will deliver a superior return of total equity trajectory versus peers over the next couple of years, which is not reflected in current valuations,” declare the bank analysts at RBS Australia. “Maintain Buy and preferred sector exposure”.

Unfortunately for National Bank ((NAB)) shareholders, the RBS analysts will be feeling a bit Robinson Crusoe. Their Buy rating stands alone in the FNArena broker database.

Last month NAB pre-issued the basic numbers within its full-year profit result and highlighted an increase in provisions for both UK and domestic exposures, which basically affected a profit warning. At that point most analysts were little surprised, having felt NAB had been slow to top up provisions against bad debts and even after having done so, had not yet closed the gate. Yesterday NAB's official result including all the numbers was released, and aside from a stoic RBS, there were general groans around Bridge Street.

The cash result even missed RBS' estimates and has prompted 2% forecast earnings downgrades from the broker, “entirely due to bad debts”. However RBS notes NAB's provision levels are converging on peers and with deposit competition expected to further ease, the analysts see the above mentioned improvement in return.

NAB management might be moving in the right direction, but movement has been too slow for analysts who believe it's about time management took off its rose tinted glasses. “Since the GFC,” rails UBS, “NAB has been consistently over-optimistic with respect to credit growth, inventory cycle, UK recovery etc. This has led to less conservative business settings than peers”. And trying to catch up is proving a costly process, UBS adds.

Having drawn their bows, the UBS analysts continued to let fly in their post-result report, noting NAB's “unfortunate trend of negative surprises” which has “plagued the bank for more than a decade”. Last December quarter, it was a hit to Treasury trading. In March it was a UK hit. In June it was business bank provision top-ups and in the September quarter, which wrapped up the bank's fiscal year, it was top-ups to collective provisions.

It comes down to NAB's “valuation gap” to peers. The Big Two of Westpac ((WBC)) and Commonwealth ((CBA)) are mortgage juggernauts and all round leviathans relying to a great extent on cost cutting to improve returns while continuing to chase deposit funding in a low loan growth environment. They trade at a premium to the smaller NAB, but “size doesn't matter” (so I'm constantly told) given small peer ANZ's ((ANZ)) valuation chimes with the big boys, leaving NAB on the outer. The smaller banks are seen as riskier but more nimble than the bigger banks, thus offering a higher risk/reward profile. But at the end of the day, one glaring difference is that ANZ has Asia while NAB has the UK.

While the net profit number was known earlier, the break-down delivered by NAB yesterday showed a lack of quality as well as quantity. The final figure included greater than expected profits in Treasury trading, which is nice, but what the Lord giveth the Lord can just as quickly take away in the proprietary punting game. Cost reductions provided another boost which is promising, except that analysts can't see much more room left. Once again the UK division proved it should have been shot long ago – dumped at any price – but having received uninspiring bids this year management has simply crossed its fingers in the hope of an improved UK economy.

And despite the provision top-ups, Deutsche Bank notes provision coverage remains below peers. “We believe these factors [above] will see NAB deliver a below peer return on equity,” the analysts suggest, “despite its higher risk profile, leaving the risk/reward equation uncompelling at current prices”.

Citi notes that if you include the dividend reinvestment (DRP) plan, NAB's dividend payout for FY12 came in at 77% after tax or 111% before (gross). Gross payout of organic capital generated in the past three years has exceeded 100% – “a seemingly unsustainable practice,” says Citi.

NAB has been working to steal market share in recent times, which it has done so mostly from WBC and CBA, in both mortgages (remember the “breaking up” campaign) and more ominously in business banking. Most business banking gains have come from the mining states of WA and Queensland, and are weighted towards small and medium enterprises (SME). The whole WA economy, from the pits in the Pilbara to coffee shops in Perth, rely on the mining industry. For Queensland the equation is not much different, outside of a stagnant tourism industry. With the mining boom plateauing, NAB is looking at some risky exposures.

And this is the problem for most analysts. The UK is an ever present cancer, but domestic exposures are beginning to look vulnerable. And recent provision top-ups still fall short. “Given our fundamentally bearish domestic economic outlook,” says Macquarie, “we will need to see evidence that the resources slowdown has been fully reflected in provisioning before revisiting the longer term thesis,” which revolves around gradual relief from non-core issues (eg UK).

Macquarie also challenges the RBS view on easing competition for deposits, seeing NAB's need to further drive deposit growth as offsetting the benefits of recent loan repricing (courtesy of the RBA) thus maintaining pressure on margins.

Analysts have trimmed earnings forecasts for NAB across the board, and slightly trimmed target prices to affect a reduction in consensus to $25.81 from $25.95. Given NAB's discount to peers, which out of context makes NAB appear “cheap”, Hold is the rating of choice for most. BA Merrill Lynch is sticking with Underperform nevertheless, and JP Morgan retains its sector Underweight, while as noted above, RBS is a lone Buy.

Shareholders can at least rest easy that NAB's consensus forward yield for FY13 of 7.3% stacks up well against Westpac's 6.5% and CBA and ANZ's 5.9% (all fully franked). Solid yield in a yield-hungry world limits share price downside, but as noted above, Citi worries about the payout ratio ahead. 
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms