Given the tighter scrutiny on banks such as Westpac Shares (ASX WBC), now more than ever, a transformation is imperative to meet regulatory and compliance needs, especially with the ongoing issues surrounding the Royal Commission. Even though we don’t think this will have a major impact on Westpac shares profitability, it is inevitable for Westpac to invest in accountability enhancement and risk management. Regardless of the issues, we show you why the Westpac share price today is a buy.
Westpac stock, as one of Australian ‘big four’ bank, has the nation’s largest branch network and ranks second by market capitalisation. It provides various banking and financial services through five divisions including Consumer Bank, Business Bank, BT Financial Group, Westpac Institutional Bank, and Westpac New Zealand. The group prioritised return over growth, delivering the economic profit of $3,774 million with ROE at 13.8% in FY 2017.
Managing Headwinds But Delivering a Solid Result
APRA has strengthened the supervision mechanism for the mortgage sector. As Australian second-largest mortgage lender, Westpac was in the center of the storm. To cope with the requirements, Westpac overhauled its lending policy of foreign property investors and coal mining projects. Meanwhile, Westpac cash earnings growth of 3% was primarily offset by a 5% increase in capital charge as the group prepared for APRA capital requirements.
However, WBC shares Cash Earnings Per Share (EPS) rose 2% to 239.7 cents, as the group delivered robust net profit growth of 7% in FY2017. The robust result was attributed to the high-quality loan portfolio, adequate funding and improved liquidity position. Westpac maintained conservative debt targets, and priority was given to deposits this year. Stronger growth of deposit lengthened the tenor of funding relative to global peers.
Further sell-down of BT Investment Management, the underperforming wealth management and insurance division, lifted the net profit by $279 million. It should be noted though that the one-off investment gain comprises nearly 50% of the net profit growth.
Fintech and Regulation Changes Will Alter The Landscape in 2018
Australia banking sector is on the front foot of regulatory and compliance changes, with the expected upgrade of Basel standards (reforms of Risk Weighted Assets) and the Fundamental Review of the Trading Book (a revised market risk framework). Additionally, PWC Australia has already initiated training and consulting program for the banking industry.
Despite all this, Westpac shares are still Australian the most cost-efficient bank measured by cost-to-income ratio. Westpac’s cost-to-income rate of 42% is lower than the industry average of 43.4%.
Fintech is also reforming the value chain across the majors. The upcoming New Payments Platform (NPP) would lead to a wave of innovative digital payments services, especially for mass payments between financial institution. Westpac also joins this real-time payment revolution at a relatively moderate pace.
A key investment priority for banks is to attract and retain the next generation of customers where Westpac has done well. The company launched Service Revolution program in 2017. With enhanced mobile banking and multiple technology innovations, the program reduced customer complaints by18%. Other than ‘Big Four’, small banks who are not able to confront rapid digital changes will be left languishing behind. Given the substantial change in the industry, Westpac’s prompt transformation enhances its mid-to-long term competitiveness.
At the current time of writing, the Westpac share price today had a current P/E ratio at 13.16, while Commonwealth Bank (ASX CBA) stands at 13.61 and Australia & New Zealand Banking Group (ASX ANZ) at 14.63. Not only does the WBC share price trade at a discount to peers, a forecasted drop in 2018E P/E to 11.89, would also be an incentive for investors to jump in. The Price to Book (P/B) of 1.77 is reasonable, as Westpac ranks second by asset amongst major banks.
Net interest margin(NIM) decreased 4 basis points to 2.06% in FY 2017. However, the industry indicator even drops 5 basis points compared to 2016 to 2.01%. That could be attributed to the rising investment and compliance costs to cope with potential volatility in the interest rate. Thus, Westpac’s ability to balance loans and funding cost is still top level. WBC share price Earning Per Share (EPS) is expected to rise in FY18 to 241.6 cents, ahead of NAB and ANZ.
FY17 ‘Big Four’ Financial performance
Westpac shares Earning Per Share (EPS) is expected to rise in FY18 to 241.6 cents, ahead of National National Australia Bank (ASX NAB) and ANZ. Partly due to the sector-leading earnings per share (EPS) growth of 3.8%, Goldman Sachs forecasts the company’s FY 2018 net interest margin will outperform its peers.
Forecast EPS of Big Four (cents)
In spite of underperforming the broader market, the Westpac shares are expected to generate sector-leading financial performance in FY2018, on the back of robust profitability and net interest margin expansion. High efficiency and strong productivity empower the company to stabilized amid changes in regulatory and technology landscape. With the underperformance of the WBC share price against the broader market, the Westpac share price today looks to be a good buy and the stock could be undervalued.
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Henry is a co-founder of MF & Co. Asset Management with over 12 years experience as a trader, investor and asset manager. Henry’s focus is on High Net Worth Wealth Management and using algorithmic quantitative trading systems to invest for his clients. Henry also trains new Interns and Advisers on trading and risk management.