March 28

Westpac Banking Corporation (WBC) – Earnings power under-rated

Westpac Banking Corporation is the third-largest of the big four commercial banks by market capitalisation and offers a full suite of financial services to more than 13 million customers. Westpac’s first-quarter FY24 profit of $1.8 billion was little changed from the final quarter of FY23, with interest margin pressure and higher bad debts well managed. Despite some modest pricing changes recently, headwinds from customer deposit price competition and switching and home loan discounting, persist and are expected to see margins ease further in 2024. Concerns about Westpac’s ability to compete should be subsiding though, as the bank is now growing deposits and home loans in line with the market, in fact, even growing ahead of the market in the six months to December 2023. Bad debt expenses a share of loans increased 3 basis points to 0.10%, below our FY24 forecast of 0.12%, and medium-term expectation of 0.17%. With credit stress rising from low levels, it is likely bad debts have bottomed, but the bank is sitting on large provision balances which will help soften the impact on earnings.

As margins shrink and bad debts creep higher, earnings growth will be challenging for the Australian banks in the short term, but the current share price paints too bleak a picture on the medium-term earnings power of Westpac, in our view. Over the next five years, we assume rational competition returns for pricing loans and customer deposits. As the second-largest lender and deposit holder, Westpac should be a willing participant as it stands to benefit materially. Most Australian banks, excluding Commonwealth Bank, face single digit return on equity in FY24, compared with our assumed 9% cost of equity, supporting our view that current loan and deposit price competition is unlikely to persist indefinitely. Shares in Westpac are undervalued compared with our unchanged $28 fair value estimate.


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