Hot Stock: National Australia Bank (NAB)

Friday 13th May 2016

Promising signs

What’s new?

While it is still early days for National Australia Bank’s refined business model, the evidence to date has been encouraging. For the six months ending 31 March 2016, National Australia Bank reported a 6.5 percent increase in cash earnings and a more modest but still positive 2.7 percent increase in underlying earnings. With the exception of NZ Banking, all of NAB’s operating segments made a positive contribution to the bank’s cash earnings for 1H16.

From an earnings perspective, the key driver in 1H16 was the 6.3 percent increase in the bank’s net interest income to $6.6 billion, with this having been partially offset by a 3.5 percent decline in other operating income and a 4.2 percent increase in operating costs. Importantly, the key driver of the decline in other operating income was due to adverse movements in economic hedges, lower trading income and lower sales of risk management products.

In terms of NAB’s core business, we note that the 2 basis point increase in the 1H16 NIM to 1.93 percent was due to the benefits of repricing in home lending and deposits that more than offset higher wholesale funding costs and competition for business lending. To this end, NAB has continued to invest in its priority segments (as evidenced by the 4.2 percent increase in operating costs) and the recent decision to pass on in full last week’s rate cut.

The other positive point to note about NAB’s 1H16 results was the 6 percent decline in the bank’s bad and doubtful debts to $375 million. While the bank’s bad and doubtful debts did increase by 7.6 percent sequentially on the back of a small number of large single name exposures, the loss rate remains in reasonable shape relative to both NAB’s historical average and the likes of ANZ Banking Group (i.e. 32 basis points).

It was also pleasing to note that NAB’s cash earnings did make a positive contribution to the bank’s CET1 ratio. However, on a sequential basis, NAB’s CET1 ratio declined from 10.24 percent in September 2015 to 9.69 percent. The key drivers of this were the sequential increase in the bad debts charge, dividends, loan book growth, and the demerger of Clydesdale Bank. Importantly, the bank’s CET1 ratio still remains above management’s target of 8.75-9.25 percent.

The fact that NAB maintained its interim dividend at 99 cents per share supports the view that management is comfortable with the bank’s current capital position. Furthermore, while the bank’s 1H16 payout ratio of 78.8 percent is above management’s target range of 70-75 percent, we note that the DRP will bring the net payout ratio down to circa 69 percent (i.e. assuming a participation rate of 12 percent) in 1H16. At any rate, dividends appear sustainable based on current metrics.

Outlook

There is no doubt that the Australian banks are currently facing a number of earnings headwinds, both structural and cyclical. However, the key reason for becoming more positive on the bank’s shares is our view that the full earnings benefit of recent restructuring initiatives is set to become apparent in another 6-18 months.

Price

NAB is currently trading at 11.6 times the rolling 12 months forward consensus earnings estimate, which represents a discount to the average of the four majors at 12.7, and offering a prospective dividend yield of 6.9 percent. In our view, NAB’s positive fundamentals are consistent with the stock’s technical set-up, with the next band of resistance located between $29.68 and $30.43 over the near-term.

Summary

While it is still early days for NAB’s refined business model, we believe that the signs to date have been positive. With NAB’s capital, funding, and asset quality seemingly in reasonable shape and the business now showing some operating momentum after an extended period of change, we conclude that the bank’s shares currently offer good value relative to both its major peers and the broader market.

James Lennon is a Senior Analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE

Disclosure: NAB is held in the Fat Prophets Concentrated Australian Share and Australian Share Income models.

Comments from our readers

No comments yet