NAB Bites The Dividend Bullet

This story features NATIONAL AUSTRALIA BANK LIMITED. For more info SHARE ANALYSIS: NAB

National Australia Bank has reduced its dividend pay-out in the first half, largely as expected, although a capital raising came as somewhat of a surprise to brokers.

-First half result would have been worse if not for better-performing wholesale bank
-Brokers generally consider a build in capital and reduction in the dividend are the right decisions
-NAB retains the flexibility to consider all forms of exiting MLC
 

By Eva Brocklehurst

National Australia Bank's ((NAB)) income growth was erased in the first half by an additional $95m in customer remediation charges, although a strong markets division helped offset the weak conditions in retail banking and wealth management.

Bell Potter suggests the first half result would have been worse if not for the better-performing wholesale bank. However, dilution from the raising of equity in FY19 is seen largely offsetting the underlying earnings growth relative to peers.

Macquarie considers National Australia Bank is in better position than peers because of an underweight position in Australian retail banking, as slowing volume growth, fee pressures and competition do not bode well for the near-term outlook of retail franchises.

Strong growth was witnessed in NZ housing, with a 9% increase in the second half of FY18, a positive in Credit Suisse's view. There was also a 3% reduction in general expenses achieved through productivity savings and the broker considers capital generation was reasonable.

Still, impaired loans increased. The bank pointed out there were a few troublesome exposures that caused bad debt charges to increase to $449m in the half. The increase in arrears highlights emerging stress for highly geared households, Morgan Stanley asserts, albeit new impaired loans have increased off a low base. The broker suspects that loan loss normalisation has begun and forecasts impairment charges to increase to 18 basis points in the second half and 21 basis points in FY20.

Shaw and Partners notes the bank delayed increasing its standard variable rate by four months and suffered the consequences. Morgans, too, remains mindful of the loss of operating momentum on the home loan front, amid the departure of CEO Andrew Thorburn and the more significant remediation charges that may be pending.

While the bank considers it is "broadly on track" to achieve cost savings Morgans suspects that it is falling behind on productivity-related aspects and sticks with a Hold rating. Ongoing uncertainty around management and the future direction of the business make it hard to have a more constructive view, hence, Macquarie also maintains a Neutral rating.

Morgan Stanley asserts the building of capital and the reduction in the dividend are the right decisions and the risk of de-rating is lower than for the other major banks, and Bell Potter concurs that this is a commercially sensible outcome that would only be positive for the bank down the track.

Bell Potter not one of the eight stockbrokers monitored daily on the FNArena database, lowers operating income estimates because of the subdued conditions while increased cost efficiencies suggests flat underlying costs in 2019 and 2020. The broker maintains a Buy rating and $27.60 target.

Dividend/Capital Raising

The interim dividend was re-based to $0.83 a share from $0.99. Many brokers have argued for some time that the bank needed to re-set its dividend and this was not a surprise. The quantum was larger than Credit Suisse expected and the timing of a capital raising was a surprise, although this ultimately removes two uncertainties. The bank will raise around $1.8bn through a discounted dividend reinvestment plan (DRP) and a partial underwriting.

Credit Suisse incorporates a dividend of $0.83 per share per half for FY19 and FY20 and envisages scope for small increases in FY21. Bell Potter considers the bank has finally addressed its relatively weaker capital base and this no reason why the pay-out ratio should not increase in the medium term.

Morgan Stanley, on the other hand, does not believe the dividend can grow and DRP neutralisation appears unlikely. Adverse outcomes relating to New Zealand regulatory changes or remediation could mean there are further initiatives needed to top up capital in the future.

Shaw and Partners calculates, if the bank has set this dividend on the basis of a 70% pay-out ratio, then annual cash earnings per share of $2.40 is achievable. Refunds to customers were considerable and such items are likely to be present in the second half, the broker notes.

The bank is unable to provide an indication of the proportion of the $1.3bn in fees allocated to aligned financial planning groups from 2009 to 2018 that will be returned to clients. This compares with the refund rate of 31% currently provision for clients of salaried advisers.

National Bank has reaffirmed it is on track to meet the minimum 10.5% CET1 requirement by January 1, 2020. This does not take into account higher NZ capital proposals but Bell Potter believes the bank has sufficient options to mitigate the risk. This includes re-pricing actions, reducing lending and may be either divesting assets in Australia or de-merging NZ operations.

Business Lending

Business lending continues to be one of the bank's strengths, with 4% growth in non-housing loans in the half year. However, Shaw and Partners points out there was a decline in both Australian business and home loan margins to a similar extent. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $28 target.

Ord Minnett prefers National Australia Bank because of its growth and margin outcomes in SME (small-medium enterprise) lending, the NZ business and corporate & institutional banking. The broker considers this more than offsets the challenges in the smaller consumer and wealth divisions.

The bank has pointed out that the intended public markets exit of MLC is delayed to FY20 while it retains the flexibility to consider all forms of exiting the business. Morgans believes a trade sale has become more difficult amid a more challenging regulatory and operating environment.

FNArena's database shows three Buy ratings four Hold and one Sell (UBS, yet to comment on the result). The consensus target is $26.53, signalling 3.0% upside to the last share price. Targets range from $23.00 (UBS) to $29.50 (Citi). The dividend yield on FY19 and FY20 forecasts is 6.5%.

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