Westpac Banking Corporation (WBC)

Fat Prophets

Monday 12th May 2014

What’s new

Westpac Banking Corporation recently delivered another solid set of numbers, with both first-half statutory and cash profit rising and the underlying quality of results impressive.

In the six months to 31 March 2014, robust performances were posted in almost all its operating divisions. This led to group cash earnings lifting 8 per cent year on year to $3,772 million, albeit marginally boosted by contributions from the recently-acquired Australian businesses of Lloyds Banking Group. Westpac continues to look after its income hungry shareholders, announcing an interim fully franked dividend of 90 cents per share, up 4 cents or 5 per cent year on year

Despite a 7 per cent rise in operating expenses to $4,195 million, management continues to run a tight ship, with Westpac’s expense-to-income ratio falling to an industry-leading 41.2 percent in the reported first half.

Outlook

We saw nothing in the interim results to change our long-held view that Westpac is one of the best exposures to the Australian banking sector, given its strong market presence, enviable capital position and solid expense discipline.

Despite the relatively subdued economic environment, management continues to deliver solid earnings growth by focusing on productivity gains and clamping down on credit risk. Indeed, impairment charges in the first half dropped by $97 million, or 22 percent compared to the year ago period.

All this is reflected in the bank’s impressive return on equity (ROE) which, on a cash basis, improved to 16.5 per cent in the interim period, up from 16.1 per cent a year ago. Critically, the financial position remains pristine, with Westpac boasting common equity tier 1 (CET1) capital ratio of 8.82 per cent, comfortably above the preferred range of 8.0-8.5 percent and well in excess of regulatory requirements.

While further improvements in these metrics will be harder to come by going forward, the strength of Westpac’s fundamentals certainly provides significant comfort with respect to the medium term outlook.

Price

Despite the solid first-half result, the reaction on the bourse has been muted since the announcement. However, this is merely due to the stock’s stellar performance in recent times. In fact, shares in Westpac have appreciated over 50 per cent over the past two years, comfortably outperforming major bank peers.

Worth Buying?

In our view, Westpac is likely to continue generating solid earnings growth and return on capital going forward, driven by the quality of the management team and strength of its overall franchise. The strength of the bank’s capital position is also such that further special dividends may be on the medium term horizon.

However, the stock is now trading at circa 14 times forward earnings estimates and 2.2 times book value. As these are no bargain-basement multiples, we believe it is prudent for those without exposure to wait for a pull back in price before buying into shares of Westpac Banking Corporation.

Greg Smith is the Head of Research at Fat Prophets.

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