Dividend Downgrade

The first-half FY19 result from National Australia Bank was in line with our expectations, with stronger-than-expected income from its markets division helping offset challenging conditions in its retail banking and wealth management operations, but the 16% cut in its interim dividend stole the headlines.


The bank posted strong performance in all divisions except the consumer and wealth operations. The retail business saw very challenging conditions, which are market-wide factors, but these were exacerbated in NAB’s case by its decision to reprice its mortgage book later than its peers. However, the other divisions – business and private banking, New Zealand and corporate and institutional banking (CIB) – all delivered stronger pre-provision profit versus a year ago and NAB’s business banking bias remains the key to our investment thesis.


NAB rebased its interim dividend to $0.83 per share from $0.99, a more severe cut than we had expected (our dividend forecast was $0.90 a share).


We have argued for some time that the bank needed to reset its dividend, and the consequent 70% underlying payout ratio leaves NAB well-positioned to deal with further customer remediation costs and build capital to meet higher New Zealand regulatory capital requirements. A 1.5% discount will apply to the dividend reinvestment plan and NAB will also partially underwrite the plan to raise $1.8bn in aggregate, representing around 45 basis points of capital, which will see its core equity tier-one ratio move well above the 10.5% minimum level mandated by the Australian Prudential Regulation Authority.


NAB indicated that the transformation agenda remains on track with all targets reiterated. There was a note of caution, however, that compliance costs are a bigger headwind than expected when the program was first outlined.


The underlying result demonstrated why we prefer NAB in the bank sector – that is, good growth and margin outcomes in small- and medium-sized enterprise lending, the New Zealand business and CIB, which offset challenges in the smaller consumer banking and wealth division.


We have reduced our net profit forecasts by around 3% across our forecast period and our target price has fallen slightly to $28.60 from $29.80. We see the stock as screening attractively versus its peers in what is a very difficult Australian retail banking environment and we maintain our Accumulate recommendation.

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