Stemming Cost Growth Critical For NAB

Array
(
    [0] => Array
        (
            [0] => ((NAB))
        )

    [1] => Array
        (
            [0] => NAB
        )

)

This story features NATIONAL AUSTRALIA BANK LIMITED.
For more info SHARE ANALYSIS: NAB
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

National Australia Bank's weighting towards business banking, versus retail, is expected to remain supportive going forward but brokers note elevated expenditure leaves the bank vulnerable.

-Could be difficult to achieve profit growth in FY18
-Reduced confidence in ability to stem costs growth
-Performance of business & private bank critical to growth outlook
 

By Eva Brocklehurst

Revenue trends are expected to deteriorate for National Australia Bank ((NAB)) in the second half, unless mortgages are re-priced, which Macquarie suggests could be a likely outcome if funding pressures persist.

Management has noted that whilst re-pricing mortgages has been the main driver of higher margins, a shift in mix towards higher-margin, smaller SME customers should mean upside is sustained in the future.

Brokers suspect expenses growth will pick up in the second half and agree, in the short term, this leaves the bank exposed to declining earnings. Nevertheless, business banking operations demonstrated strong growth and a solid outlook in the first half.

Macquarie notes the dividend reinvestment plan discount will be dropped for the first half dividend, suggesting participation is likely to fall to around 10%. The broker also notes asset quality trends remain sound as the credit impairment charge was better-than-expected in the first half, achieved despite improved collective provisions coverage.

Citi was disappointed with the result because revenue growth was lower than expected, and also suggests the restructuring plan has removed the flexibility to adjust costs when revenue growth is lower.

The largest division, around 45% of cash earnings, is business & private banking which offers genuine potential for outperformance, and the broker believes this puts NAB in a better position than its peers.

Citi maintains a Buy rating, even though the relative outperformance makes the stock less compelling than previously. The broker believes lower exposure to retail and institutional banking outweighs the challenges of a large multi-year restructuring plan.

Credit Suisse continues to support the strategy and the bank's willingness to address its cost base over the medium term but has become more cautious on the revenue side.

The broker suspects the inflexible cost base in the short term will mean that near-term earnings are affected before the full benefits of the current strategy are likely to be realised.

UBS also suggests the benefits of the large restructuring plan may be less than the bank anticipates, given the underlying revenue trends.

Expenditure

Ord Minnett shares some investor concerns about the wide target range of 5-8% on underlying costs growth in FY18 yet points out the bank has less exposure to retail banking, which is only around 25% of group profit, and there is potential for margin upside in business banking as well as upside from the divestment of the wealth business.

Macquarie acknowledges the level of the bank's current expenditure is highly elevated, partly as a result of underinvestment, historically, and partly because of a desire to better position for the future. In the short term, brokers agree, this leaves the bank exposed to declining earnings.

Ultimately, Macquarie expects success will be evident beyond 2020 if costs can be contained or improved on in subsequent years. Although there is execution risk, the broker continues to envisage longer-term value in NAB.

Taking a counter stance, Morgan Stanley finds the trading multiple hard to justify and has reduced confidence in the three-year cost guidance. The broker asserts the reinvestment burden, capital position and elevated pay-out ratio leave the bank vulnerable to operating and regulatory challenges.

Cost savings will need to increase and growth in underlying expenses slow for the bank to achieve its guidance for “flat” cost growth in FY19, in the broker's view.

Brokers note the CET1 ratio is at the lower end of the range for the major banks. The CET1 ratio of 10.2% was slightly below Ord Minnett forecasts but NAB is observed to have a path to 10.5% and will be are less affected than its peers by the changes by APRA to the capital framework.

The broker envisages the dividend is safe, unless there is a significant change in industry fortunes, while a 7% yield is attractive.

The CET1 ratio also missed Morgan Stanley's forecasts, with the broker believing the optimisation of non-housing risk weightings has come to an end. Meanwhile, future capital generation appears modest given the elevated pay-out ratio.

Admittedly, Morgan Stanley understands there is over $3bn, or over 75 basis points of capital, in the wealth management business.

MLC

The bank has announced plans to divest its MLC wealth management business (this does not include JB Were or the private bank), either via a de-merger, IPO or trade sale. This is expected to be carried out by the end of 2019. Return on equity is expected to increase subsequently.

However, Citi suggests a de-merger as opposed to a trade sale, is likely to put pressure on the dividend as the bank shrinks its capital and earnings base, again.

FNArena's database shows six Buy ratings and two Sell (Morgan Stanley, UBS). The consensus target is $31.04, suggesting 7.1% upside to the last share price. Targets range from $27.10 (Morgan Stanley) to $33.50 (Morgans, yet to update on the result). The dividend yield on FY18 and FY19 forecasts is 6.8% and 6.7% respectively.

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