Westpac profits a signifier of strong performance ahead

Peter Gardner

Plato Investment Management

The outlook for income investors looks remarkably bright, especially when you consider how things were looking just six months ago.

Today, Westpac outperformed expectations and has more than doubled profits for this quarter, with first-half investor report showing cash earnings were at $3.5 billion, up from $1.9 billion in 1H20. This welcome news supports the notion that Australian banks have navigated the COVID-19 crisis exceptionally well and now we think Australian investors, particularly the mums, dads and retirees, can breathe a sigh of relief. 

The significant write-back of provisions by Westpac is something investors should see repeated across the board, with ANZ and NAB due to report this week and CommBank will be reporting its quarterly the following week. Westpac has said it aims to reduce its cost base by approximately $2 billion by 2024, bringing targets to $8 billion, down from $10.2 billion in FY20. 

While the massive cash earnings growth comes from a low base, it’s certainly encouraging for the sector as a whole. Investors suffered through Westpac's AUSTRAC fines which put a sting on its performance last year. 

By the numbers... 

  • Interim dividend is 58 cents per share
  • Payout ratio is at 60%
  • Cash earnings are at $3.5 billion up 256% on 1H20, and up 119% compared to 2H20
  • Net profits are up 189% on 1H20, and up 213% compared to 2H20
  • Cost base target is now $8 billion for FY24, down from $10 billion in FY20
  • CET1 capital ratio is 12.34%, up 153 basis points

Dividends are at a major turning point

The reinstated interim dividend comes in significantly above that paid in 2020 and importantly puts in on a 6.6% annualised gross yield, with a payout ratio that is conservative at 60%. 

We are also encouraged by Westpac’s increase in net interest margin and strong CET1 capital ratio of 12.3% well above APRA’s 10.5% unquestionably strong level, giving it scope to return capital to investors in the future. 

While income from cash-backed assets continues to languish fortunately we are in the midst of a major turning point for dividend income, buoyed by the strong recovery of financials and also the continued strength of our major miners.

We are still expecting a strong second-half payout from the other Big Four banks: ANZ, CBA and NAB. At the end of last quarter, CommBank signalled it is likely to pay out 70-80% of earnings over the year (compared to 67% at the end of December). 

CBA has previously signalled, during the February reporting season, it would like to use its franking credits for capital management. But while a lucrative off-market buyback may be on the cards later this year, it is difficult to predict exactly when. 

We are calling this the turning point for dividends, and are expecting the trajectory to continue for the next two to three years as the banks' dividends per share return to pre-COVID levels. 

What does this mean for the rest of the market? 

Westpac's results were partially driven by the buoyancy of the property market and the lower than expected business impairments. In the long term, if the economy was to rebound strongly we would expect business lending to increase, which would be good for the banks. This would undoubtedly bring to bear on the other part of the market as well.  

We project the ASX200 is on track to return around 5% gross yield in the coming 12 months. This would be driven by financials and the materials sector. Our major miners, including Rio Tinto (ASX:RIO) and Fortescue (ASX: FMG), are all going to be incredibly strong. 

We're also expecting continued, sustainable growth in the consumer discretionary sector which are also solid dividend providers. Our conviction in this sector, especially holdings such as Super Retail Group and JB Hi-Fi, continue to be strong. 

Want to learn more about retirement income?

Plato Investment Management is an Australian owned boutique equities fund manager specialising in maximising retirement income for pension phase investors and SMSFs. To find out more click "contact" below. You can also keep up to date with Plato on Linkedin. 

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Peter Gardner
Senior Portfolio Manager
Plato Investment Management

Peter is a Senior Portfolio Manager and manages the Plato Australian Shares Income Fund. He is a founder of Plato and has 15 years investment experience. Peter received 1st Class Honours and a PhD from UNSW.

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