Westpac delivered a clean first-half FY18 result with a cash net profit of $4.251bn, up 5% on the same period last year, and ahead of our $4.223bn forecast. The result was assisted by a larger-than-expected rebound in the markets business and low provision expenses.
The highlight of the result was a strong net interest margin, which rose 3bp, excluding markets, to 2.05%. We also made the following observations:
- Revenue of $11.153bn was 1% below our estimate, with weaker net fees and commissions providing the main drag.
- Expense growth declined to 1% half-on-half, despite a material step up in group expenses driven by regulatory and compliance costs, including $34m associated with the Royal Commission.
- Asset quality was solid, with bad and doubtful debts declining to $393m, equating to 11bp to gross loans and acceptances versus our 13bp forecast.
- Westpac further lowered its exposure to interest-only loans, which dropped to 40% of its Australian housing portfolio, bringing it closer to its major bank peers.
- An interim dividend of 94c per share was declared, versus our 95.0c forecast, with the dividend reinvestment plan retained at no discount.
One criticism we have heard of Westpac recently is that it lacks cost flexibility, with expenses growth likely to be stuck in the 2–3% range for some time. However, we see medium-term upside potential from cost savings once the customer services hub is rolled out – albeit likely a three-years-plus scenario.
We expect things get tougher from here for Westpac given pressure on retail margins from interest-only loan switching and competition, but we think recent share price weakness has more than priced this in. When we look at the broader business, we also see a balance between: 1) a bank with strong customer offerings – including digital – across retail and business banking; 2) a leading wealth manager with the modern Panorama platform capable of competing with new entrants; and 3) an institutional bank that has strong relationships with its large customers.
Westpac has underperformed the sector over recent months and we continue to believe the stock looks good value at current share price levels. We maintain our Accumulate recommendation with a target price of $33.10.