Those that tipped Westpac (WBC) as a big cap to do well in 2020 have some catching up to do. Australia’s second-largest bank, and 4th largest listed company, has fallen 46% in FY20 to date in absolute terms while it's underperformed the market by ~25% (excluding dividends).
But if we cast our minds back to the GFC, the nadir of bad debts and associated recapitalisation of the banks set up a strong medium-term buying opportunity. This begs the question, are we there yet?
I was a watching a video earlier in the week from a market commentator filling airtime on the banks. A 15-minute diatribe later, they took a breath and we got an intimate history about what’s gone wrong with the sector in the past, and why they’ve been such a terrible investment. What was clearly missing was the outlook / expectation for the future. While we use history as a guide, I feel like the recent history of the banks is tainting investor appetite to buy them at these currently depressed levels.
What's the outlook for Westpac from here?
Westpac have this morning released 1H20 results and there wasn’t a lot of new news from an earnings perspective - 1H20 was very similar to 2H19 with a few swings and roundabouts. Net interest income increased by 1% from 2H19 to 1H20 as a result of no change in net interest margins and a small increase in loans.
Non-interest income declined by 18% from 2H19 to 1H20 with the insurance businesses responsible for most of the decline. Banking fee income declined as well. Expenses increased by 3%, excluding notable items, from 2H19 to 1H20 and a decision on the interim dividend was deferred and I expect it will probably not be paid.
WBC’s cash net profit fell from $3.5B in 2H19 to $1B in 1H20 as a result of a $1B charge for AUSTRAC and $2.2B bad debt charge in 1H20. The size of that provision suggests WBC is being more conservative than both ANZ and NAB, however like the others, they are using the base case of a V shaped recovery in their economic assumptions.
WBC forecast a 5% contraction in GDP in calendar 2020, before growth of 4% is achieved in 2021, a similar dip then recovery in both unemployment and house prices. Time will tell if this is accurate however as Buffet said over the weekend, there is a very wide set of possible economic outcomes from this global pandemic.
Would I buy it?
The underlying result today was better than feared, the bad debt charge had been flagged, a 'known known' while their decision to defer the dividend is sensible. Tier 1 capital sits at 10.8x and they have flagged the potential of asset sales, which I think is a real positive in today's update, particularly the advice business, it's all too hard in that space. By deferring the dividend and flagging asset sales, WBC is trying very hard not to raise capital, and at this stage, it’s unlikely.
From here, WBC earnings will to a large degree be a function of economic activity and how we exit the CV-19 shutdown. Clearly, if you’re buying WBC today, you’re in the V-shaped recovery camp. I think from a risk/reward perspective, a fairly dire outcome is being priced into Westpac and the upside potential here is strong. I’m in the ‘V’ camp simply given the level of stimulus in the Australian economy.
The market remains bearish & underweight the banks and this sets up the opportunity. While valuations are rubbery short term, the consistency of underlying bank earnings over time is high. Furthermore, the fact only one major bank has raised equity here is testament to how well capitalised they are.
The case to buy banks into current weakness with a medium-term mindset in my view is strong.
For WBC, a recovery back to $25 has every chance, which is a +60% gain from current levels.
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James - interesting write-up. Let's not forget WBC's big institutional and SPP issue in Nov/Dec last year which has allowed them to provide for and cover its AML issues. NAB's jumbo raising has taken a chunk of equity capital that, given the timing, could have benefited ANZ and WBC if not for its prior raising. The adequacy of provisioning, or over-provisioning, will be worth watching.
The implementation of CET1 at 10% post-GFC is showing to be a masterstroke by the authorities (can't think of the right word atm). Aussie banks are strong and can withstand all the low punches. The new broom Peter King was always going to do a clean sweep - that it has coincided with CV19 is a bit of luck for him. The NAB CR gazumped ANZ and WBC. I think that they will do a CR but they need the NAB one to be cleared away first although it will make it hard for them to set a price. Getting through the next twelve months will see banks in clear air and then that $25 mark should be well in sight.