NAB released its third-quarter trading update and delivered strong unaudited cash earnings of $1.65bn, down 3% on the quarterly average for the first half but ahead of the run rate inferred by Ord Minnett’s second-half earnings estimate of $3.2bn. Bad debts were slightly better than expected, while revenue growth of 1% was ahead of our flat forecast for the second half and expense growth was slightly lower at 2%.
The net interest margin (NIM) appeared relatively resilient, down only slightly despite funding cost headwinds. Capital was also a little softer, but we expect risk-weighted asset growth to normalise at a lower level in the fourth quarter given the third quarter is typically strong for business lending. NAB’s common equity tier-one ratio of 9.7% was weak, reflecting the 2% growth in risk-weighted assets.
NAB also flagged provisions for compliance programs, although the amount was not identified. These will be on top of the expected 5–8% underlying cost growth in FY18 – we have penciled in $150m.
Some concerns remain about execution risk surrounding NAB’s investment program. Despite this, and the further regulatory costs that have been flagged, we are encouraged by the better revenue trends, and we continue to believe NAB’s positioning in the small-to-medium enterprise segment suggests strong revenue growth prospects.
Our underlying cash EPS forecasts have increased by less than 1% over the FY19–20 period on an assumed better second-half NIM. However, we have reduced our FY18 cash EPS forecast by 1.4% to reflect one-off compliance provisions. Our target price has lifted to $32.20 from $30.00. The stock is trading on an FY20E P/E multiple of just 11.4x, so we maintain our Accumulate recommendation and retain NAB as our preferred stock in the sector.