Westpac Bank (ASX:WBC) Stock Analysis - April 2015

Overview
Westpac (ASX:WBC) was established in Sydney in 1817. It is Australia's oldest bank and financial services provider headquartered in Sydney, NSW. It also has offices in Singapore and Hong Kong. It is one of Big 4 banks in Australia and is also second-largest bank in New Zealand. It serves more than 8 million customers with almost 1200 branches and a network of more than 2900 ATMs. 
Its core business units are:
  • Retail (Consumer) and Business division
  • Corporate and Institutional division
  • Wealth Management division
Australian banks, which includes Westpac (AA credit rating), were among the few banks in the world that came unscathed from the global financial crisis (GFC).

Competition
Banking industry in Australia is a classic case of oligopoly. An oligopoly is a market structure in which a few firms dominate. Australian banking industry is dominated by the Big 4 banks - CBA, NAB, ANZ and Westpac. Together, the Big 4 banks control more than 90% of the regulated market. As a result, Big4 banks together make it difficult for new players to gain any market share. Big 4 banks also hold cost advantages over their small competitors due to massive economies of scales.

Westpac's vast network of branches (over 1200) poses significant challenge (high barrier for entry) for new entrants to threaten its market leader position. Westpac's focus on regional multi-brand strategy, marked by the launch of 'Bank of Melbourne' in the year 2011, is helping the bank set itself apart from competitors. 

Although fierce competition exists between the Big 4 banks, neither local regional banks (which tend to follow Big 4 trends) and nor foreign banks are in a position to pose any meaningful threat to the Westpac's dominant position in the foreseeable future.

Warren Buffett, arguably the world's greatest investor, often emphasis buying businesses with pricing power, i.e. businesses that can increase prices without losing customers or market share to competitors. Banking is a highly regulated commodity business and as such banks do not hold any pricing power (it is more or less dictated by the RBA cash rate). Big 4 banks are no exception in this regard, they do however, set and define the baseline prices in the mortgage market, which other smaller banks tend to follow.

Revenue
The following graph outlines the revenue growth of Westpac in the last 10 years.
As can be seen from the graph above, revenue has grown by more than 2 folds in the last ten years from AUD 8.7 billion to AUD 19.9 billion in 2014. Westpac recorded growth in revenue with 3 year, 5 year and 9 year growth rate (CAGR) at 6%, 4% and 10% respectively. Even during the GFC in 2009, Westpac managed to increase revenue by 10%. During the last ten years, Westpac increased its shares by whooping 70%. The effect of share dilution is visible in the revenue per share growth rate, with 3 year, 5 year and 9 year revenue per share growth rate coming in at 3%, 0% and 3% respectively.

Earnings
In order to arrive at the owner's earnings, the cash based 'R&D' expenses and non-cash 'Depreciation, Depletion and Amortisation' expenses have been added to the reported Net Income.

The graph below shows the reported earnings, owners earnings and cashflow in the last 10 years.
In the last ten years, the owner's earnings have tripled (approx) from AUD 2.9 billion to AUD 8.6 billion in the year 2014. Westpac recorded moderate growth in earnings with 3 year, 5 year and 9 year growth rate (CAGR) at 4%, 16% and 13% respectively. During the GFC (2008-2009) Westpac owner's earnings increased by 6% but EPS fell by 25% as a result of share dilution. The effect of share dilution is also visible in the earnings per share growth rate, with 3 year, 5 year and 9 year eps growth rate coming in at 1%, 12% and 6% respectively.


Below is the earnings growth breakdown for the year 2014:
  • Westpact retail and business banking reported 10% increase in earnings.
  • St George reported 14% increase in earnings.
  • BT Financial reported 16% increase in earnings
  • New Zealand reported 25% increase in earnings.
At the time of this writing, Australia is going through soft credit growth, which may have an impact on the short term earnings growth.

Australia's superannuation industry is one of the fastest growing industry in wealth management, with compulsory super contribution to rise to 12% by the year 2022. This should provide some consistent earnings growth and a cushion to soft credit conditions.

Expense vs Income
In the last 10 years, Westpac has spent an average of 12.5% of its owners earnings on 'R&D', 'Property, Plant and Equipment' and 'Purchase of business'.

The graph below outlines the 'Earnings vs Expense' ratio in the last 10 years.

During the last 10 years, Westpac spent a sum total of AUD 7.7 billion on acquisitions, which comes to mere 11% of total owners earnings during the same period.

Westpac gained entry into the lucrative wealth management sector through the acquisition of Rothschild, BT Financial Services and Hastings in the 2000s.

Westpac acquired St George bank in the year 2008 in the midst of the GFC.

Westpac acquired RAMS home loans in January 2008 and operates the RAMS distribution business and brands as part of the St. George group.

Westpac sold it's banking operations in Samoa, Cook Islands, Soloman Island, Vanuatu and Tonga for $125 million to Bank of South Pacific.

Bad Debt
The graph below outlines the 'Credit loss provisions' in the last 10 years.
Global financial crisis exposed the bad debts made during the boom year. The credit loss provision nearly soubled fold from AUD 482 million to AUD 932 million in 2009.

PE ratio
The graph below shows the PE ratio trend in the last 10 years.


Return on Equity 
The graph below outlines the ROE trend in the last 10 years.

As can be seen, the ROE has been quite stable except the GFC and has been consistently more than 15%.

Dividend
The graph below outlines the dividend per share trend in the last 10 years.

Westpac has steadily increased dividends, paid two special dividends in fiscal 2013. In the last 10 years, the dividends have increase of 8.1%. A CAGR of 8.1 implies, dividends doubling every 9 years.

The current dividend payout ratio sits at an uncomfortable 115%.

Yield
The graph below outlines the buyback, shareholder and dividend yield trend in the last 10 years.

In the last 10 years, the dividends have increase at a fantastic CAGR of 8.1%. Westpac has returned a total of AUD 30.8 billion to its shareholder through dividends. Currently, Westpac has a dividend yield of 7%. I expect that in future, the dividends are more likely to grow at a CAGR of 4-6% due to very high dividend payout ratio of 115%.

In total, Westpac has been able to return 58% of its total owner's earnings to shareholders through dividends and share buybacks.

Risk
It is estimated that together, Westpac and CBA, control more than 50% of the home loan market. At the time of this writing, approximately 67% of all Westpac loans are mortgage loans and remain profitable. This is a positive sign because when compared to other asset classes, mortgage lending is considered low-risk venture. The downside is that it exposes Westpac to downturn in property market.

Several economists believe that house prices in Australia (especially in Melbourne and Sydney) are over-valued by upto 30 percent. Concerns about a market bubble and subsequent crash have often been made. Only recently, Glenn Stevens, governor of RBA, made a remark that Sydney house prices "look rather exuberant". Some of the commonly cited reasons behind heated property markets are:
  • Foreign buyers (China)
  • Negative gearing
  • Rise of SMSFs borrowing to invest in Super
  • Low interest rates
Some fear that in case of a housing market correction, Australian banks may suffer the similar (horrible) consequences as the banks in America did during sub-prime mortgage crisis. While it is true that Australian housing market is expensive and affordability is an issue, Australian banks are in a much better position to handle a correction due to:
  • Strict underwriting standards
  • Lender's mortgage insurance for loans for 80% LVR
  • Full recourse lending
  • High proportion of variable rate home loans
  • Possibility of rate cuts by RBA
Low doc loans were cited as major culprit in subprime mortgage crisis in the US. Within Australia, regulations stipulate that low doc loans with an LVR of over 60% be covered by lenders mortgage insurance which insurance the bank against the risk of default on loans. Interestingly enough,  LMI is paid by the borrower but insurances the bank. 

Future
Banking industry is correlated with the macro-economic factors like, interest rate, inflation, unemployment rate and consumer confidence among other factors. Slowdown of the mining and commodity sector combined with weakened employment market may impact the revenue.

In addition, since banking is highly regulated industry, adverse regulatory changes, however unlikely, is always a threat.

Valuation
The current market cap for Westpac (ASX:WBC) stands at AUD 120 billion at a trailing PE (reported earning) of 16.30 and at a fwd PE of 14.27. At current share price ($38.39), it offers a trailing dividend yield of 6.77%.

Full Disclaimer: I am not a financial planner. The views expressed in this post are all mine and they may or may not suit your needs. Please do you own due diligence. I do not make money on any of the products suggested in this post.

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