Westpac-k of opportunity amidst challenges
Westpac (ASX:WBC) reported its 1H22 results on 9th May, delivering better than consensus estimates, but the share price has nosedived ~20% ever since. We think the vicious sell-off is sparked by fears surrounding the impact of rising interest rates. We take a stock of the bank’s 1H22 earnings to decipher if the ongoing dip is due to a negative signal or does it pose a buying opportunity.
The bank posted a 5% drop in net profit to $3.3 billion in 1H22 vs. 1H21, primarily hit by competition in its consumer and business division. The cash earnings were down 12% to $3.1 billion during the same period, but up 71% vs. the previous half, led by a significant reduction in the notable items. Lower cash earnings over 1H21 were attributed to a turnaround in impairment charges (from a benefit of $372 million to a charge of $139 million) and constrained net interest margins. However, excluding the notable items, the core earnings registered a 6% growth and 10% drop vs. 2H21 and 1H21 respectively. Cash earnings on the same basis declined 1% and 19% over 2H21 and 1H21, respectively.
Source: Westpac bank (ASX:WBC) presentation
Westpac’s net interest margin witnessed a 22bps squeeze to 1.85% in 1H22 over 1H21, owing to intense competition. The severe competition was spurred by a low-interest rate environment, where the lenders were competing to offer the best mortgage rates to customers, in turn taking a hit on their margins. However, we anticipate the rising interest rate landscape to ease some pressure off margins, as it offers the bank benefits of re-pricing its mortgages in tandem with the rate hikes. On the flip side, higher interest rates may lead to a rise in non-performing loans. Moreover, this would deter people from spending more, while encouraging them to build their nest eggs, resulting in slowing credit growth. Moreover, higher interest rates also signal increased cost of funding, further compressing the NIMs.
Source: Westpac bank (ASX:WBC) presentation
A look at the bank’s aggressive cost restructuring strategy: the expenses were reduced by 27% and 10% (excluding notable items) in 1H22 vs. 2H21, including cutting down over 4000 jobs. The bank reiterates being on track to achieve the $8 billion cost target by FY24. It anticipates the cost to be modestly lower by 0-2% sequentially in 2H22, resulting in ~$10 billion costs for FY22. Even so, the market is taking this with a pinch of salt, as the cost target has underlying assumptions and as the bank’s peers walk away from their cost-cutting plans, given rising inflation. We think if management can move up a gear, then it will strengthen its bottom line in the coming years.
Source: Westpac bank (ASX:WBC) presentation
The bank also had some happy news for the income-seeking investors. It declared a fully franked interim dividend of 61 cents vs. 58 cents in 1H21, pointing towards sustained earnings growth.
We also noted improved credit quality metrics with most returning close to pre-covid levels. Stressed exposure dropped to 1.1% of total committed exposure (TCE) as at Mar-22 from 1.6% as at Mar-21. This is underpinned by a sound provision coverage, with higher overlays for floods and uncertainties.
Source: Westpac bank (ASX:WBC) presentation
Westpac is on track to improve the digital experience for its customers with the rollout of a new app, enabled for 200+ features and capabilities. Furthermore, the bank plans to offer money management functionality to its customers and digitize over 400 manual processes by the end of 2022.
The bank’s common equity tier 1 (CET1) ratio dropped to 11.3% in 1H22 vs 12.3% in 2H21, owing to an increase in the interest rate risk in the banking book (IRRBB) risk-weighted assets (RWA). However, we anticipate the bank to maintain a stable balance sheet with the CET1 ratio within the bank’s new operating range of 11.0%-11.5% and within APRA’s requirements.
Westpac (ASX:WBC) recently struck two deals with Mercer Australia to merge BT’s personal and corporate superannuation funds and offload Advance asset management business. The bank anticipates an after-tax profit of $225 million over FY22 and FY23, collectively from both the deals and deliver an ~8bps rise in the bank’s CET1 ratio. The deals are subject to regulatory approvals and are likely to be concluded in 1H23. This would offer an important headway to Westpac’s ongoing agenda of exiting its non-core businesses.
Going forward, we project the net interest margins to improve, led by the rate hikes passed on to the customers. Westpac’s chief economist Bill Evans revised forecasts for the RBA to raise interest by 50bps at successive two meetings to finally settle at 2.6% vs. the previous 2.3%. “Effectively 90 percent of mortgage borrowers are directly exposed to moves in the RBA cash rate over the next year and a half,” he quoted.
Our take
We remain optimistic about Westpac (ASX:WBC), despite the challenges ahead, primarily backed by its cost savings strategy, dividend yield, digitization strategy, and improving credit quality metrics. The bank is likely to witness margin pressures over the medium-term, as the easing impact of rising interest rates is likely to be offset by slower credit growth. However, the asset quality is anticipated to remain stable, as the bank claims that majority of its customers are well positioned on mortgage repayments to deal with a rate increase. We believe that as the economy turns the corner with curtailed inflation, credit growth will see demand, in turn boosting the bank’s earnings growth. The bank’s valuation looks attractive with a discounted FY23 PE multiple of 10.5x, vs. its peer average of ~12x. offering a good buying opportunity post the big sell-off.
We recommend Westpac (ASX:WBC) shares as a buy to Members without exposure.
Disclosure: Interests associated with Fat Prophets hold shares in Westpac (ASX:WBC).
