And Then There Was NAB

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

– NAB disappoints on dividend
– Domestic business okay, UK the drag
– UK improvement appearing
– Capital management soon?

By Greg Peel

National Australia’s Bank’s ((NAB)) interim profit beat consensus estimates by about 0.5%. The announced 93c interim dividend is 3c ahead of last year’s interim and 1c ahead of consensus forecasts. Under normal circumstances, such a result would be well received. In the current environment, however, NAB has proven the poor cousin among rivals ANZ Bank ((ANZ)) and Westpac ((WBC)).

Both ANZ and Westpac posted profit “beats” of a greater magnitude than NAB. ANZ increased its dividend significantly and declared an ongoing target payout ratio of 80%, up from a previous 65% target. Westpac’s dividend was in line with expectations and no change was made to the bank’s already peer-leading payout ratio, but Westpac offered up a 10c special dividend instead.

In a yield-hungry market, NAB has thus proved a disappointment. NAB’s share price has run up 33% this year and outperformed the bank index by 8%, having started from behind. Having assumed ANZ to have set a precedent on capital management two weeks ago, the market bought up the other banks in anticipation. Westpac delivered, NAB did not.

While the market may have been disappointed, analysts were not surprised. It comes down to NAB’s legacy UK business, which has proven no less than a disaster since the GFC. NAB has tried in the interim to offload its albatross, but no one has been silly enough to stump up. Management has simply had to grin and bear it, and ride out a lengthy and costly recovery process.

Take the UK out of the equation, and NAB’s interim performance was much the same as peers. Domestically the bank saw a reduction in bad debt charges, particularly in business banking, and booked some impressive market trading income. Like peers, NAB felt a 3 basis point squeeze on net interest margin and its wealth business struggled. Capital generation was strong, with an 8.22% tier one capital ratio well ahead of the bank’s 7.5% target. NAB is not as exposed to New Zealand and Institutional banking as peers, and thus is avoiding additional pressure on margins. On the other hand, business banking’s growth outlook remains subdued, so bad debt reductions will continue to be needed to drive profits.

The level of impairments in NAB’s UK business continue to worsen. UK property prices outside of London are still falling, and the UK economy remains weak. Citi believes NAB is yet to see the peak in UK bad debts. The good news, nevertheless, is that the rate of new impairments has slowed and provisioning is solid, in line with UK peers. As the loan book starts to run off, Deutsche Bank believes NAB’s UK bad debt charge “should reduce materially from here”.

Macquarie is also enthusiastic about NAB’s UK impairment charges having apparently turned the corner. There is a real possibility, suggests Macquarie, the new Bank of England governor will eschew the policies of his predecessor and “go for growth”. If so, the next twelve months could see further impairment charge declines in NAB’s exposures.

NAB’s Australian business is in no better or worse shape than peers, and all banks are facing a low earnings growth outlook, reduced margins on lower base interest rates and struggling wealth management businesses. All have enjoyed renewed risk appetite in the market and subsequent trading profits, although analysts suggest the first half 2013 will probably prove a stand-out. All are enjoying reductions in lingering bad debts, which should continue to provide an earnings offset to low credit demand. All are in strong capital positions vis a vis new international requirements.

Only NAB has the UK, and the UK has crimped the bank’s group profit result and constricted any ability to improve capital management for the benefit of shareholders. But capital management remains a possibility in the short term if the UK run-off continues favourably. NAB may yet still buy back its dividend reinvestment plan (DRP) shares in the second half, management has indicated, thus reducing resultant earnings dilution. Analysts were expecting DRP buybacks from both ANZ and Westpac, but both banks opted for cash in hand to shareholders instead, no doubt playing to the current mood. A payout increase from NAB might yet be a 2014 story, or maybe even a second half 2013 story.

So on all of the above, is NAB cheap or expensive, particularly given its solid 2013 run? Here analyst views diverge.

Of course, a more general argument is one of whether or not all the banks are expensive right now. Here bank analysts have been forced to throw away the old rule book and simply assess whether bank yields in a low global interest rate environment are enough to support prices. Almost begrudgingly the answer seems to be yes, but as to whether the banks can run further still is another matter.

On a relative basis, Macquarie (Outperform) believes NAB is delivering on its turnaround story. Deutsche Bank (Buy) believes NAB is well placed to deliver above-peer growth over the next two years and that this is not reflected in the share price. Goldman Sachs argues NAB’s sustainable return on total equity (ROTE), which post-result is up to 18.0% from 16.9%, suggests NAB’s discount to peers is excessive. JP Morgan suggests gradual improvement in the UK book matched with around a 21% ROTE domestically provides cause to Overweight NAB within the sector, but against the market JPM can’t see momentum continuing in the near term after the solid run.

NAB is CIMB’s preferred pick among the Big Four, offering the capacity for above-peer growth in return on equity out to FY16. CIMB sees NAB as relatively cheap at a 10% discount to peers, but on a market basis maintains a Neutral rating. UBS (Neutral) believes NAB is no longer cheap on a 5.8% yield. Citi (Neutral) cites poorer funding, lower margin and weaker asset quality than peers. Credit Suisse (Neutral) wants to see more improvement in the UK and Morgan Stanley (Equal-weight) is not yet convinced loan losses have turned.

BA-Merrill Lynch simply needs “more comfort that further negative surprises do not await”, and is sticking with Underperform.

Of the Big Four, NAB is the most open to risk, being not only one of the two smaller banks but the only bank exposed to the UK. With increased risk comes more price volatility, but also the opportunity for greater reward. Perhaps this is evident in a 3/4/1 Buy/Hold/Sell split among brokers in the FNArena database. A consensus $31.15 price target suggests 4.1% downside from Friday’s closing price.

Commonwealth Bank ((CBA)) runs on June year-end (December interim), but will provide a quarterly update on Wednesday. Investors will need to wait until August to learn of any new capital management initiatives.

Previous stories:

Westpac And Macquarie: More Yield
Australian Banks: For And Against
ANZ Result: Stock And Sector Implications
 

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