Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Equity Bottom-Up

Wide-moat-rated <a href="https://www.smartkarma.com/entities/444" target="_blank" data-smartkarma-citation="entities:444:1">Westpac Banking Corp (WBC AU)</a> remains our favoured major bank and is attractively priced following the recent share price pullback. Westpac is trading at a 12% discount to our unchanged AUD 35 fair value estimate and is currently the most attractively priced Australian major bank based on valuation. Westpac benefits from high exposure to the economically strongest and most populous states of New South Wales and Victoria, and possesses marginally better earnings growth prospects than peers due to higher expected net interest margins and better operating efficiency. The bank is well positioned for higher expected regulatory capital requirements and should, overtime, successfully manage down its exposure to interest-only home loans. Our EPS growth forecasts are underpinned by steady credit growth, broadly stable net interest margins, and a best-in-peer group track record of loan underwriting and risk-management standards.Despite a track record of low loan losses, we modestly increase our forecasts to account for increasing risks from the interest-only home loan portfolio. Our fiscal 2017 cash earnings forecasts adjust down to AUD 8.19 billion from AUD 8.23 billion but remains higher than consensus estimates of AUD 8.15 billion. The key attraction for Westpac is its globally impressive operational efficiency, underpinned by a peer group low sub-42% cost/income ratio. At current prices, Westpac trades at a 12.8 P/E multiple, 1.8 times price/book, and 2.2 times price to tangible book. Our fiscal 2017 forecast dividend yield of 6.1% grosses to a very attractive 8.7% when adjusted for franking credits. Recent price weakness is overdone, as Westpac suffered more than peers from a round of unimpressive interim financial reports in early May, higher-than- peer levels of interest-only home loans, and increased political scrutiny, culminating in the federal government’s bank levy, followed by a similar levy announced by the South Australian state government.We retain our positive long-term view, and in our opinion, the key near-term share price catalyst is a more benign outcome on capital rules when Australia’s financial regulator clarifies “unquestionably strong,” expected in the next month. Downside risks include a tougher-than-expected outcome from the regulator on “unquestionably strong” and or a shorter time frame to raise the additional capital. Attractive forecast returns on equity around 14% are well above our 9% cost of equity assumption and at the top of management’s guidance range of 13%-14%. For every dollar of income, Westpac makes 58 cents of gross profit--that is, profit before bad debts and tax.Another near-term catalyst is a better-than-expected financial performance from Australia’s largest bank, <a href="https://www.smartkarma.com/entities/14" target="_blank" data-smartkarma-citation="entities:14:1">Commonwealth Bank Of Australia (CBA AU)</a>, when the bank reports fiscal 2017 results on Aug. 10, 2017. Improving operating conditions across the economies of Australian and New Zealand will also benefit bank share price performance. Further evidence that Westpac can continue increasing revenue at a faster pace than expense growth, thereby improving cost/income ratios, will be positively received by investors.Analyst: David Ellis

Wide-moat-rated Westpac Banking Corp (WBC AU) remains our favoured major bank and is attractively priced following the recent share price pullback. Westpac is trading at a 12% discount to our unchanged AUD 35 fair value estimate and is currently the most attractively priced Australian major bank based on valuation. Westpac benefits from high exposure to the economically strongest and most populous states of New South Wales and Victoria, and possesses marginally better earnings growth prospects than peers due to higher expected net interest margins and better operating efficiency. The bank is well positioned for higher expected regulatory capital requirements and should, overtime, successfully manage down its exposure to interest-only home loans. Our EPS growth forecasts are underpinned by steady credit growth, broadly stable net interest margins, and a best-in-peer group track record of loan underwriting and risk-management standards.Despite a track record of low loan losses, we modestly increase our forecasts to account for increasing risks from the interest-only home loan portfolio. Our fiscal 2017 cash earnings forecasts adjust down to AUD 8.19 billion from AUD 8.23 billion but remains higher than consensus estimates of AUD 8.15 billion. The key attraction for Westpac is its globally impressive operational efficiency, underpinned by a peer group low sub-42% cost/income ratio. At current prices, Westpac trades at a 12.8 P/E multiple, 1.8 times price/book, and 2.2 times price to tangible book. Our fiscal 2017 forecast dividend yield of 6.1% grosses to a very attractive 8.7% when adjusted for franking credits. Recent price weakness is overdone, as Westpac suffered more than peers from a round of unimpressive interim financial reports in early May, higher-than- peer levels of interest-only home loans, and increased political scrutiny, culminating in the federal government’s bank levy, followed by a similar levy announced by the South Australian state government.We retain our positive long-term view, and in our opinion, the key near-term share price catalyst is a more benign outcome on capital rules when Australia’s financial regulator clarifies “unquestionably strong,” expected in the next month. Downside risks include a tougher-than-expected outcome from the regulator on “unquestionably strong” and or a shorter time frame to raise the additional capital. Attractive forecast returns on equity around 14% are well above our 9% cost of equity assumption and at the top of management’s guidance range of 13%-14%. For every dollar of income, Westpac makes 58 cents of gross profit--that is, profit before bad debts and tax.Another near-term catalyst is a better-than-expected financial performance from Australia’s largest bank, Commonwealth Bank Of Australia (CBA AU), when the bank reports fiscal 2017 results on Aug. 10, 2017. Improving operating conditions across the economies of Australian and New Zealand will also benefit bank share price performance. Further evidence that Westpac can continue increasing revenue at a faster pace than expense growth, thereby improving cost/income ratios, will be positively received by investors.Analyst: David Ellis

Westpac Bank's Earnings Outlook Supports Our Top Ranking; AUD 35 FVE Unchanged