Margin Squeeze | Westpac Banking Corporation (ASX:WBC) Recommendation

Ord Minnett Research Recommendation:   Westpac Banking Corporation (ASX: WBC)  

Westpac reported an FY21 cash net profit of $5.35bn, slightly below Ord Minnett’s $5.41bn forecast but 105% ahead of FY20. The bank’s second-half headline cash net profit was 3% below our estimate, while revenue was in line. A final fully franked dividend of 60c per share was declared, for a full-year dividend of $1.18 per share versus our $1.16 expectation.

Most concerning to us was the net interest margin (NIM), which fell 9 basis points (bp) half-on-half excluding one-offs, or 6bp excluding markets, treasury and liquidity. This was 5bp worse than we expected and points to further revenue pressure in FY22.

Costs were 6% above our estimate, offset partly by a net provision release (we had forecast a small charge), including a large collective provision write-back which significantly reduced coverage. Second-half costs were also 6% higher. Management said it was on track for its $8bn cost target by FY24, although it was coming from a higher starting point, and we think inevitably the cost savings will be back-end weighted to FY23 and FY24.

Despite the 7.4% fall in the share price following the result (versus a 0.6% increase in the S&P/ASX 200 Index), the cost strategy looks risky and revenue is yet to find a floor.

We have reduced our cash net profit forecasts by 10% in FY22 and 9% in FY23, reflecting our 4% revenue cuts and 2–3% increase in costs. We now forecast $8.2bn of underlying costs in FY24, below our previous $8.4–8.5bn assumption, although it will still require a big effort to achieve.

Overall, Westpac’s outlook is highly uncertain, in our view, with weak customer franchise metrics and revenue under pressure driven by compression on mortgage margins. The bank’s FY24 cost plan is ambitious given it requires a 20% reduction from the FY21 cost base. Westpac has a solid capital surplus, but this is not dissimilar to peers and collective provision coverage is now at the bottom end of the peer range.

In this context – and given our long-term concerns about the sustainability of mortgage margins across the industry where Westpac has a heavy exposure – we see the risk-reward balance as unfavourable. We maintain our Hold recommendation, while we have trimmed our target price to $24.50 from $27.00.