Goodbye Clydesdale, Dividend Now The Issue For NAB

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

-NAB facing margin pressure
-Capital ratio still modest
-Dividend pay-out may be a stretch
 

By Eva Brocklehurst

National Australia Bank ((NAB)) has pushed ahead hard with its plans to return to native soil, outlining the process by which it will offload its troubled UK asset, Clydesdale Bank. Brokers are now intent on seeking out what this means for NAB's future dividend sustainability.

The bank has published documents detailing the de-merging and listing Clydesdale Bank in the UK. NAB is offering 75% of Clydesdale to shareholders at a ratio of 1-for-4 and this stock will have a primary listing on the London Stock Exchange and a secondary listing on ASX.

NAB also proposes to sell up to 25% through an initial public offer (IPO) to institutional investors which would be listed on the London Stock Exchange. The proceeds of this IPO will be retained by NAB to strengthen its capital position.

The de-merger is expected to be implemented by February 8, 2016. Then, NAB will have left its UK play entirely. NAB shareholders will retain the same holding in the local entity as before but also hold new securities, which represent 75% of their previous indirect interest in Clydesdale. They will be able to liquidate their Clydesdale holdings subsequently and allow new investors to take over the charge.

Citi believes the financial metrics of the proposition are weak as Clydesdale is being divested below book value. The remaining capital ratio for NAB, at 8.95%, is also considered too modest and the broker suspects there will be pressure on NAB's dividends.

The management of Clydesdale is indeed optimistic, UBS contends, perhaps too optimistic in targeting a more than tripling of pre-tax profit by 2020. Still, NAB can now focus solely to Australasian operations. UBS believes the bank is well placed to gain locally from an acceleration in business credit growth but faces margin pressure in re-engaging with customers.

This difficulty offsets the expansion in mortgage interest margins and limits the earnings recovery, in the broker's view. NAB will also need bad debt charges to remain around current low levels in order to keep its dividend intact post the de-merger, the broker suspects.

Deutsche Bank also considers the financial targets for Clydesdale ambitious but the sale should allow NAB to redouble its efforts at the local level. The broker suspects Clydesdale's cost/income ratio of 75% will be challenging to achieve.

NAB's pro-forma returns should rise to a relatively healthy 14.6% post the de-merger but there are still areas of concern for Deutsche Bank. The main issue is the business banking margin and elevated pro-forma pay-out ratio of 77%, which appears a stretch given further capital demands are likely.

Deutsche Bank uses a FY16 price/earnings ratio of 11.5 to value the Australian business, based on a 10% discount to Westpac's ((WBC)) ratio. This valuation discount has increased which reflects NAB's weak second half result and margin headwinds.

De-merger assumptions, while generous, are realistic in Credit Suisse's opinion. Still, it is an expensive transaction to execute, with all up costs for NAB approaching $500m. NAB has confirmed it will enter an underwriting agreement prior to the announcement of the IPO price, which should enable protection of its own capital position, and that pleases the broker.

The issue of dividend sustainability is raised, nonetheless. Credit Suisse believes dividend can be sustained but there is further pressure on capital dynamics with this de-merger. More pressure is also expected to emerge following completion of the life insurance divestment.

The broker values NAB as fully mature restructuring story with some earnings headwinds, assessing it to be the most vulnerable of the big four in relation to dividend sustainability. Credit Suisse prefers the Australian mortgage oriented major banks for customer re-pricing leverage.

FNArena's database has six Hold ratings for NAB and one Buy (Macquarie). The consensus target is $33.03, signalling 13.6% upside to the last share price. Targets range from $30.10 (Morgan Stanley) to $37.84 (Macquarie). The dividend yield on FY16 and FY17 forecasts is 6.8% and 6.9% respectively.
 

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