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NAB Dividends Likely Safe

Australia | Feb 07 2017


National Australia Bank's first quarter update held few surprises. Revenue growth was subdued and brokers are mindful of the challenges in maintaining the dividend pay-out.

-Provisioning at lowest level in 12 months as mining, agricultural risk exposure eases
-Cost growth outstripping pace of revenue growth, despite higher financial market income
-Long-term value envisaged as business credit growth shows signs of improvement


By Eva Brocklehurst

National Australia Bank ((NAB)) delivered a first quarter update that held few surprises for brokers. The bank posted $1.6bn in quarterly cash earnings. Revenue growth was subdued, up 1%. Underlying margins were stable, as competition for deposits eased, while trading revenues were strong on the back of high levels of volatility. Provisioning improved relative to the second half of FY16.

Provisioning was that its lowest quarterly level in 12 months, $80m below Ord Minnett's expectations, given the non-repeating overlay for mining and agricultural exposure. The broker expects a typical seasonal uplift in the second quarter for provisioning. Elevated expenses growth of 5% is expected to improve over the year from efficiency initiatives, which should mean there is sufficient capital generated to maintain a flat dividend at an 80% pay-out ratio, in the broker's view.

Net interest margin was broadly stable in the first quarter following a decline of 11 basis points over the second half of FY16. The flat margin in the first quarter suggests to Ord Minnett that the recent re-pricing of selective mortgage products is offsetting the flowing through of higher deposit costs.

Credit Suisse was slightly disappointed with the update and believes it sets a subdued tone for the bank reporting season. The broker did not like the fact that costs growth is outstripping the pace of revenue growth, even though revenues benefitted from higher financial markets income. The broker believes banks are facing a difficult underlying profit environment, despite asset quality metrics remaining stable amid modest consumption of capital.

Dividend Should Be Maintained For Now

The stock offers some credit quality and good cost discipline in Morgan Stanley's view, but an improvement in revenue growth is needed to drive upgrades to earnings-per-share estimates. The broker does not expect housing and business loan growth to surprise on the positive side and, with margins still under pressure, now factors in subdued revenue growth of around 2% for FY17.

The broker assumes a further 10 basis points of re-pricing across the mortgage portfolio but believes this is increasingly likely to be skewed towards investment property loans. Morgan Stanley also expects a flat dividend outcome. Consensus assumes FY17 profit of around $6.6bn and the broker believes this will be a challenge, unless loan losses stay under 15 basis points or revenue growth improves.

The outlook is more positive in Macquarie's opinion, with mortgage re-pricing benefits, a more rational competitive environment and productivity benefits supporting earnings growth, and an elevated dividend is likely to be supported in the near term, especially while capital rules are being finalised. The broker continues to envisage longer-term value for the stock, particularly as business credit growth shows signs of improvement.

Morgans observes the bank continued to run off below-returning institutional exposures over this first quarter and this would have weighed on loan growth. It would also explain why the bank's Australian loan growth was well below system loan growth, despite its home loan growth being just slightly below system.

The broker's base case is that the bank will keep its nominal dividend flat for FY17 but suspects it will be reduced this year, as NAB is seen as having the most stretched dividend pay-out ratio relative to returns on tangible equity of all the major banks. Over time, the bank is aiming to reduce its dividend pay-out ratio to within its long-term range of 70-75%.

Stock Screens Cheaply

CLSA believes that the stock, having consistently performed below its peers, now trades cheaply and there is scope for it to positively re-rate. The bank remains the broker's favoured stock among the major banks. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, has an Outperform rating and $33.82 target.

Deutsche Bank was pleased with the update, as there were few surprises compared with updates of the past. While the broker believes this justifies a further re-rating versus peers, it concedes the operating environment is challenging, with revenue growth low despite a flat net interest margin. Nevertheless, with the stock looking inexpensive, and the tilt towards small business banking likely to deliver better net interest margin, the broker retains a Buy rating.

UBS is more cautious, believing the bank is progressing with its turnaround but, given the rally in recent months, the broker remains on the sidelines with a Neutral rating. UBS believes the improvement in impairments in the quarter is a "catch up" to the other banks. While asset quality trends remain broadly stable, the broker expects charges will inevitably rise from current levels throughout the year.

There are three Buy ratings, four Hold and one Sell (Morgan Stanley) on FNArena's database. The consensus target is $30.85, signalling 0.8% upside to the last share price. Targets range from $28.50 (Morgan Stanley) to $34.50 (Credit Suisse).

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