Expenses Drag

National Australia Bank reported cash earnings of $6.6bn in FY17, 2% ahead of our forecast. The strong result was due largely to a more significant margin expansion than expected, with net interest margins (NIM) up across all divisions. A final dividend of 99c (fully franked) was declared, taking the full-year dividend to 198c per share.


Group NIM was up 6bp, while the cash net profit to risk-weighted assets metric rose in all divisions, if we exclude Corporate & Institutional Banking’s lower trading income. Asset quality and capital were also positive. NAB’s return on equity gap to ANZ Banking Group (ANZ, Accumulate) was a healthy 190bp, and management’s renewed focus on its core operations continues to pay dividends.


The market’s focus, however, was on two major announcements regarding costs: 1) a $500–600m restructuring program, the benefits of which were offset by 2) a flagged 5–8% increase in underlying costs in FY18. The cost step-up largely reflects accelerated investment spending, rising amortisation expenses and, we suspect, the adoption of more conservative expensing policies.


We believe these are the right moves to ensure NAB is fit for the challenges ahead, but we were surprised by the quantum of the increase in costs, with investment spending likely to be well ahead of that of NAB’s larger peers. In addition, NAB firing such a big bullet on costs with little financial benefit to show for it clearly disappointed the market.


We have adopted the midpoint of cost guidance in our forecasts, which has led us to reduce our FY18 cash earnings estimate by 7% with the inclusion of a $650m restructuring provision and 6.5% underlying cost growth. Our FY19 forecast remains unchanged, but we have increased our FY20 number by 2% to reflect better second-half revenue momentum and unchanged costs. We have assumed NAB manages to maintain its first-half FY18 NIM at second-half 2017 levels, before margins decline steadily by about 3bp per annum out to FY20.


We maintain our Hold recommendation on NAB and have raised our target price slightly to $31.00 from $30.00.

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