How the big four fare in the dig­i­tal race

In­vestors must know what this means to the bank stocks

The Weekend Australian - - WEEKEND WEALTH - DAVID WALKER David Walker is ASX large-caps port­fo­lio man­ager at Clime As­set Man­age­ment.

Sud­denly the bank­ing sec­tor is alive with the buzz­words of the dig­i­tal age: digi­ti­sa­tion, ar­ti­fi­cial in­tel­li­gence, ro­bot­ics, big data, ma­chine learn­ing and, of course, pre-empt­ing dis­rup­tion from fin­techs. No longer staid gen­er­a­tors of dusty files of cus­tomer loan and de­posit pa­pers, banks now em­ploy some of the most prom­i­nent tech­nol­ogy lead­ers.

And it makes sense: it’s im­per­a­tive to en­able cus­tomers to in­ter­face dig­i­tally with their bank when they want, on the de­vice they want, and to use tech­nol­ogy to re­duce the costs of bank­ing pro­cesses or to elim­i­nate them. Cus­tomers al­ready ben­e­fit from the con­ve­nience and ease of the new tech­nol­ogy, but, de­spite the cur­rent race for the ti­tle, it is un­likely any one bank will emerge with a sus­tain­able com­pet­i­tive ad­van­tage in dig­i­tal bank­ing. Most likely banks will set­tle into a game of var­i­ously catch­ing up, leapfrog­ging and falling be­hind peers — and all at a sub­stan­tial cost.

Let’s look first at NAB, which has made head­lines with a very am­bi­tious re­struc­tur­ing pro­gram. Af­ter an 11 per cent rally from a Septem­ber low of $29.83 Na­tional Aus­tralia Bank shares have cor­rected since the fis­cal 2017 re­sult — not over con­cerns with the re­sult, which was solid and im­pres­sive, but with the surge in ex­penses in 2018 as man­age­ment ac­cel­er­ates its digi­ti­sa­tion strat­egy.

New ex­pense growth guid­ance of 5 to 8 per cent for 2018 was way above mar­ket ex­pec­ta­tions and is driv­ing con­sen­sus earn­ings down­grades for 2018.

The digi­ti­sa­tion costs out­weigh the sav­ings from the net 4000 po­si­tions NAB plans to re­move from the busi­ness by Septem­ber 2020. NAB will make 6000 po­si­tions re­dun­dant as tra­di­tional pro­cesses are au­to­mated or not needed any­more, but will also hire 2000 peo­ple with skills to de­liver the new dig­i­tal age. There will be a one-off re­struc­tur­ing charge of $500 mil­lion to $800m to fund the re­dun­dan­cies..

The surge in dig­i­tal ex­penses re­duces earn­ings and there­fore weighs on reg­u­la­tory cap­i­tal strength by el­e­vat­ing NAB’s div­i­dend payout ra­tio. At around 80 per cent for suc­ces­sive years, this ra­tio is too high and the con­se­quence is NAB’s de­ci­sion to dis­count the div­i­dend rein­vest­ment plan by 1.5 per cent for the fi­nal div­i­dend.

Value in­vestors will be ask­ing what all this means bank stocks? Here’s a snapshot:

NAB

At NAB the big ques­tion is whether the re­struc­tur­ing means the bank is worth less than be­fore. The an­swer is yes but not by much. The bank’s share price (about $30.50) will con­verge to an in­trin­sic val­u­a­tion of $33.50 be­cause global eq­uity mar­kets will re­main be­nign as world growth ac­cel­er­ates and in­fla­tion re­mains low, the Aus­tralian econ­omy will grow marginally next year, bank­ing in­ter­est mar­gins will be steady and bad debts low, re­turn on eq­uity will trend higher, and be­cause a pre­mium will en­ter the share price for re­li­able de­liv­ery of strat­egy. The 6 per cent fully franked div­i­dend yield in­creases the stock’s ap­peal to those seek­ing in­come with some growth. Be­low $31 NAB trades at an ad­e­quate dis­count to value.

ANZ

The small­est of the big four banks re­ported its 2017 re­sult two weeks ago. This bank is at an ear­lier stage in its turn­around, which so far has em­pha­sised de­risk­ing, cap­i­tal re­lease, di­vest­ment of non-core busi­nesses and cost re­duc­tions. The re­sult dis­ap­pointed ex­pec­ta­tions due to a lack of rev­enue growth. A year from now ANZ’s re­sults should look much like NAB just re­ported, with im­prov­ing rev­enue and earn­ings growth across the busi­ness. ANZ (about $30.30) is worth about $32.80, mak­ing the stock in­ter­est­ing be­low $30.50.

West­pac

The mar­ket ex­pected a solid sec­ond-half re­sult from West­pac, but the head­line re­sult fell short of ex­pec­ta­tions due to lower mar­kets/ trad­ing in­come and higher cus­tomer re­dress costs. Wider in­ter­est mar­gins and his­tor­i­cally low bad debts were more sup­port­ive and West­pac should ben­e­fit from im­proved trad­ing in­come, fur­ther mort­gage repric­ing and lower cus­tomer re­dress costs in the first half of 2018. Fur­ther out, mort­gage lend­ing growth will slow down fur­ther and West­pac is the ma­jor bank most ex­posed to lower in­ter­est mar­gins as bor­row­ers switch from in­ter­est-only (higher mar­gin) to prin­ci­pal & in­ter­est (lower mar­gin), so we down­graded our val­u­a­tion to $35 af­ter the re­sult. West­pac is in­ter­est­ing be­low $32. (cur­rently trad­ing at about $33).

CBA

In 2017 Com­mon­wealth Bank was the only ma­jor bank to in­crease its div­i­dend. The stock en­joyed sub­stan­tial ral­lies ahead of the in­terim and fi­nal div­i­dends. Then CBA’s first-quar­ter 2018 up­date this week beat ex­pec­ta­tions and trig­gered a bullish rally ahead of likely earn­ings up­grades. Cash earn­ings grew 6 per cent, bad debts ex­pense sur­prised on the down­side, rev­enue grew faster than un­der­ly­ing costs and reg­u­la­tory cap­i­tal was very strong. The mar­ket will now ex­pect a solid in­terim re­sult and an­other in­crease in the in­terim div­i­dend, so we ex­pect CBA ($80.90) will rally to $85-$87 ahead of the re­sult in Fe­bru­ary 2018.

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