National Australia Bank

Fat Prophets

Friday 14th August 2015

Sharechat Hot Stock - National Australia Bank

Fat Prophets see NAB staying the course

What’s new?

National Australia Bank’s trading update for 3Q15 was generally positive, with the headline cash earnings growth of 9 percent on 3Q14 arguably the highlight. The bank’s 3Q15 cash earnings was predicated on (i) a 4 percent increase in revenues, albeit aided by a favourable legal settlement and a gain on divestments, with underlying growth of 2 percent, and (ii) a 15 percent decline in bad and doubtful debts, which in combination with the strong reported revenue growth offset a 4 percent increase in expenses and a lower NIM.

While there remains some uncertainty as to what the planned divestment of National Australia Bank’s UK business will mean for the Group’s CET1 ratio, in Fat Prophets’ view, the 3Q15 update reflects positively on the bank’s recent capital raising and operating performance. According to the trading update for 3Q15, National Australia Bank’s CET1 ratio increased 107 basis points from 2Q15 to 9.94 percent.

Notwithstanding the potential adverse impact from the sale of its UK business, National Australia Bank’s current CET1 ratio compares favourably to its 1 January 2016 regulatory-based target of between 8.75 percent and 9.25 percent. However, encouragingly for investors, the recent (i.e. post 3Q15) sale of National Australia Bank’s remaining interest in Great Western Bank is expected to release around $1.3 billion of CET1 capital, which equates to circa 34 basis points, while NAB Wealth’s life reinsurance deal, which took effect on 1 July 2015, will release a further 13 basis points.

In terms of National Australia Bank’s segment performance, the bank’s release indicates that (i) Australian Banking benefited from higher volumes of housing and business lending, and lower bad debts, (ii) New Zealand Banking benefited from steady growth in volumes and higher margins that were partly offset by higher expenses and adverse currency translations, (iii) NAB Wealth benefited from favourable investment markets, and higher premiums combined with lower retail claims, and (iv) UK Banking was adversely impacted by an FSCS levy, with asset quality having improved.

While National Australia Bank continues to work towards a demerger, either through a trade sale of an IPO, of its UK business (i.e. Clydesdale Bank), no update was provided as part of the bank’s 3Q15 results. However, management did state that it was likely the UK Prudential Regulation Authority will require Clydesdale Bank to make a further £290-420 million provision as part of its UK customer conduct matter. While such a move would adversely impact National Australia Bank’s FY15 results, it will ultimately be offset against a £1.7 billion ‘conduct mitigation package’ in the event that the demerger does proceed.

Outlook

National Australia Bank’s 3Q15 trading update indicates to Fat Prophets that the bank’s (i) core businesses are performing well, with this reflecting management’s increased focus on customer service, particularly with respect to NAB Wealth, which is benefitting from its closer integration with the bank’s other segments, (ii) troubled UK business, which is showing signs of stabilising, and perhaps even returning to growth, and (iii) legacy issues are continuing to be addressed, as evidenced by the recent sale of the bank’s remaining interest in Great Western Bank.

Price

Based on the market’s consensus earnings estimates for Australia’s major banks, National Australia Bank is trading at 12.4 times the rolling 12 months forward consensus earnings estimate. While this represents a discount to the average of the four majors at 12.8 times, it is higher than ANZ Bank’s multiple of 11.4 times, comparable to Westpac Bank, and a marked discount to the Commonwealth Bank of Australia at 14.2 times. Adding to the overall appeal, particularly in the current low interest rate environment, is National Australia Bank’s current prospective (i.e. 12 months forward) fully franked dividend yield of 6.0 percent.

Worth buying

With National Australia Bank continuing to press ahead with its plan to divest underperforming assets and focus more on its core businesses in Australia and New Zealand, Fat Prophets believe now is the time to be looking at the bank as an investment. While generally considered, along with ANZ Bank, to be the poor cousin or laggard amongst Australia’s major banking stocks, this could be about to change. If National Australia Bank can succeed in bridging the gap between its cash return on equity and that of its better performing peers, Fat Prophets believe the bank’s shares can outperform.

James Lennon is an Analyst at Fat Prophets share market research. To receive a recent Fat Prophets Report, call 0800 438 328 or Click here.

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

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