Westpac: Solid Update Fails to Calm Market Concerns on Margins, Operating Costs, and Bad Debts

Westpac’s WBC third-quarter 2023 update was a little better than we expected, prompting a 3% upgrade to our fiscal 2023 profit forecast, and no change to our AUD 28 fair value estimate. Net interest margin being up 10 basis points on the first half to 2.06% is a welcome sight, but it masks an underlying downward trend reflecting competitive pressures. Still, excluding gains on hedges, NIM only fell 2 basis points to 1.96%. It is a positive outcome given we’d had some concerns around the impact of discounting being undertaken to restore momentum in home lending. On this front Westpac is making headway on growing in line with the system, growing ahead of the market in June. We still expect NIM to soften further in fiscal 2024 due to funding cost pressures, but given weak margins and poorer-than-expected returns smaller banks are reporting, competitive intensity is expected to gradually ease.

Second-half operating expenses are around 5% higher than the first half, and while higher than the 4% half-on-half growth we had forecast, a 2% reduction in full-time equivalent employees in the second half supports our cost-out thesis. Westpac appears set to cut costs by reducing headcount, as customer remediation and risk and compliance projects complete, and by consolidating office space and branches. Digitizing more of the loan application and approval process should also help.

Shares in wide-moat Westpac remain undervalued. Investors remain unconvinced the bank can grow revenue in line with peers and simultaneously achieve operating cost savings, in addition to navigating industrywide concerns for loan losses. However, we think bank balance sheets (with excess capital and loan loss provisions) and household balance sheets (with equity and saving buffers) put banks in a good position to manage a period of above-historical average levels of bad debts. Westpac trades on an undemanding fiscal 2024 P/E of 11 times and fully franked dividend yield close to 7%.