Are Westpac’s Goals Too Ambitious?

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

-Is 15% return target achievable?
-Restructuring charges unsettling
-Merit in reducing branch numbers
 

By Eva Brocklehurst

The banking industry is experiencing a rapid change in technology and Westpac Banking Corp ((WBC)) has risen to the challenge by renewing its focus on customer service.

Efficiency was the buzz word at the bank's strategy update, with a cost-to-income ratio target set to below 40% for FY18 and a reaffirmation of the 15% return on equity (ROE) target. The bank will increase spending on improving customer service and productivity with a goal of increasing customer numbers by one million.

UBS believes the customer number goal is ambitious and unusual and is a little puzzled by it, as more customer numbers do not necessarily imply profitable returns. Rather, increasing the main financial institution customers or increasing risk-adjusted revenue would be a better target, in the broker's view. In a similar vein, adding products per customer does not always correlate with more profit.

Achieving the ROE target is ambitious, UBS maintains, as banks are now required to increase mortgage risk weights to at least 25% on average and hold unquestionably strong levels of capital. To the bank's credit, Westpac does not believe such requirements should be an excuse for lower returns. Still, the broker believes it is unrealistic to expect bad debts to stay at record low levels, given the economic headwinds.

Several brokers were unsettled by the banks' decision to take restructuring charges in FY15 and FY16 below the line while reviewing its treatment of capitalised software. UBS considers this decision a throw-back to the 1990's. Write-offs might support earnings for a few years but, in the end, the broker maintains expenses have a habit of re-emerging. The bank has a track record of conservative accounting so using this restructuring lever is of concern to UBS.

Both Deutsche Bank and Goldman Sachs have set aside their reservations on this count and await further detail about the magnitude of restructuring costs before assessing the current growth trajectory in expenses. Credit Suisse, too, complains about the charges, agreeing that such expenses risk becoming recurrent. The pressure on capital, the broker acknowledges, is probably not enough to force a capital raising beyond the base case for a discounted dividend reinvestment plan (DRP).

The broker is more upbeat regarding defence of the ROE target. The bank will need to work on this but is considered well positioned given its leading exposure to investor mortgages, which have been re-priced, and its early move on productivity as well as a measured approach to raising capital.

Credit Suisse also notes the bank is intent on strengthening wealth, small-medium enterprise business and Asian growth, although predominately via links with Asia rather than being a competitor in Asian markets.

Macquarie believes the targets are somewhat conservative and the benefits of mortgage re-pricing and productivity will allow the bank to reach its targets, specifically in terms of the cost-to-income ratio. The lack of a capital raising announcement suggests the additional requirements will be met through a partially underwritten/discounted DRP between now and July 1, 2016. Moreover, the branch footprint relative to the customer base is seen improving against its peers.

Citi is less sure, believing that the ROE is aspirational. Westpac is more reliant on investor mortgages compared with its peers as well as a retail franchise built on acquiring smaller regional bank business where relationships are typically not as strong. The broker accepts there is merit in reducing the size of the branch network but the productivity targets are modest. The bank is not the productivity story many expected and Citi prefers ANZ Bank ((ANZ)) among the majors.

The reiteration of a 15% return target is more aggressive than Deutsche Bank expected. The outcome of the Basel 4 discussions is yet unknown and the broker suspects that may have a material impact on ROE outcomes for the sector. Deutsche Bank also expects the increased level of spending will be a trend across the sector in the face of competition and disruptions to traditional banking flows, in which case customers may end up being the winners rather than the banks.

Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, considers the update more evolution than revolution while welcoming the extra clarity in the outlook and retains a Neutral rating and $34.96 target.

The database shows five Buy ratings, two Hold and one Sell for Westpac. The consensus target is $35.14, suggesting 16.2% upside to the last share price. The dividend yield on FY15 and FY16 forecasts is 6.2% and 6.4% respectively.
 

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