Company Overview: National Australia Bank Limited is a business bank engaged in providing personal banking and business banking services. The Company's segments include Business & Private Banking, Corporate & Institutional Banking (CIB), Consumer Banking & Wealth Management, Customer Products & Services and NZ Banking. The Company’s Business & Private Banking focus on medium enterprises (SME) customers, which include NAB business franchise with specialized agriculture, health, Government, education and community services along with private banking and small business segment. CIB includes corporate and institutional banking businesses, fixed Income, currencies and commodities (FICC), capital financing businesses, asset servicing and international branches. Customer Products & Services include banking & wealth products, strategy, digital, NAB labs/ventures, marketing and corporate affairs. Consumer Banking & Wealth Management includes the distribution components of wealth management.


NAB Details

Amidst Challenges, Transformation Remains on Track: National Australia Bank (ASX: NAB) is a blue-chip bank with the market capitalisation of $70.89 Bn as of March 28, 2019. The bank has been making progress at a decent pace to become a better bank for the customers, employees and owners. Even though the bank witnessed some challenges in FY 2018, its transformation remains on track, thus, proving that it is fundamentally strong and can tackle the challenges in an effective way. In Q1 FY 2019, the bank’s revenues were broadly stable and there was decent growth in housing and SME lending. During the same period, the bank’s expenses were lower because the benefits of transformation are being delivered. Currently, NAB is trading at P/BV multiple of 1.30x which is below the five years’ average of 1.32x and thus proffers a decent opportunity to investors at the current juncture. We believe that the current move with regard to accepting the Royal Bank Commission’s final report and opening new branches in regional and rural Australia will support to gain the confidence of customers and communities. As of now, the bank has 316 branches in regional and rural Australia and employing more than 1600 people. Further, the bank is targeting to employ 73 specialist bankers with local experience and expertise in small business and agribusiness who will partner with regional customers to help them to grow their businesses. NAB’s leverage ratio stood at 5.2% on APRA basis in Q1FY19. Moreover, the bank is targeting to achieve APRA’s ‘Unquestionably Strong’ CET1 ratio benchmark of 10.5% by January 2020 in an orderly manner from 10.0% as at 31 December 2018. The bank enjoys respectable financials in terms of improving Group Common Equity Tier 1 (CET1) ratio, decent balance sheet position and paying regular dividends to its shareholders amidst certain challenges. Hence, considering the growth potential in the long run, we have valued the stock using 1-year forward P/BV multiple to FY20E consensus Book Value Per Share (BVPS) of $19.83; and 5-year average P/E multiple to FY20E consensus EPS of $2.4 and have arrived at the target price upside of single high-digit to low double-digit growth (in %). Key risks are regulatory risk, credit risk, liquidity risk, security risk, etc.


Key Financial Metrics (Source: Company Reports)

Decent Operating Performance in Q1 FY 2019: In Q1 FY 2019, National Australia Bank posted unaudited statutory net profit amounting to $1.70 billion and its unaudited cash earnings stood at $1.65 billion. As compared to 2H FY 2018 quarterly average, in Q1 FY 2019, the bank’s revenue was broadly stable and the sound growth in volumes got offset by the lower margins and lower markets and treasury income. In Q1 FY 2019, the bank’s net interest margin got negatively impacted as compared to 2H FY 2018 quarterly average mainly because of pressures witnessed in housing lending and lesser markets and treasury earnings. The bank managed to maintain decent CET1 ratio of 10% in Q1 FY 2019 and from the past few quarters the bank has been maintaining respectable CET1 ratio 1 in the range of 9.7%-10.2%. As at December 31, 2018, the bank had total RWA amounting to $402.35 billion which reflects the rise from $389.68 billion (as at September 30, 2018). The bank’s liquidity coverage ratio, at the end of December 2018 quarter, stood at 130% while at the end of September 2017 quarter it was 129%.
 

CET1 Ratio (Source: Company Reports)
 
Decent Fundamentals - Improvement in Efficiency Ratios: National Australia Bank is possessing decent fundamentals which might help it to achieve growth moving forward. The bank’s efficiency ratio has witnessed improvement from the past four years (FY 2015-FY 2018) which reflects that the bank has been efficient to utilize its assets to generate the revenues. In FY 2015, its efficiency ratio stood at 57.4% while, in FY 2018, it was 51.9%. We expect that the bank would continue to witness transformation benefits which might help in reducing its expenses moving forward and, thus, its efficiency ratio might also be supported.

A Look at Key Updates: The convertible preference shares which were issued by National Australia Bank Limited on March 20, 2013 were suspended from the official quotation on March 1, 2019 and were repurchased with effect from March 20, 2019. Those convertible preference shares have been removed from the official quotation with effect from close of the trading on March 27, 2019.

Recently, the bank made an announcement that Mr. Philip Chronican became Group Chief Executive Officer (CEO) of the bank, effective from 1 March 2019. Mr. Chronican is a current NAB Director and is performing this role in an interim capacity until a permanent appointment is made.

Understanding NAB Capital Notes 3: NAB Capital Notes 3 are expected to give out quarterly distributions and there are expectations that they would be fully franked. The effect of distributions being franked is to reduce the cash amount received by holders on each distribution payment date by an amount equal to the relevant level of franking. The offer size happens to be $1,650 million, with the ability to raise more or less and the net proceeds are expected to be utilized for the general corporate purposes. Also, APRA (or Australian Prudential Regulation Authority) had confirmed that these notes, once issued, would be qualifying as additional tier 1 capital for the purposes of the bank’s regulatory capital requirements.

In the recent release, the bank stated that it has wrapped up the offer of NAB Capital Notes 3. As a result, NAB issued 18,740,582 NAB Capital Notes 3 at $100 each and, thus, managed to raise around $1,874 million. In the same release, the bank added that it has also wrapped up the resale of all convertible preference shares which were issued by it on March 20, 2013 to CPS nominated purchaser in pursuant with the resale notice issued by National Australia Bank on February 11, 2019.

Rise in NII in FY 2018: National Australia Bank’s net interest income witnessed the rise of $323 million or 2.5% and stood at $13,505 million in FY 2018 which also includes a decrease amounting to $246 million which got offset by the movements in economic hedges in other operating income. However, an underlying rise of $569 million or 4.3% was because of growth in both housing and business lending volumes, coupled with full year impact of prior year repricing activities, reduced deposit costs as well as lower long-term wholesale funding costs. The bank’s total operating expenses witnessed a rise of $1,371 million or 16.1% and stood at $9,910 million.


FY 2018 Income Statement (Source: Company Reports)

Actions on Royal Commission Recommendations: The top management of the National Australia Bank had wrapped up or was in the process of implementing 26 of the recommendations. The bank announced in the month of July 2018 that it would not be charging default interest to the agricultural customers impacted by drought. Since June, the bank has repaid $110 million to 310,000 customers. It also announced a board customer committee to oversee the bank’s processes so that fair products and service outcomes can be ensured, and customer feedback and complaints can be evaluated. NAB also announced the removal of grandfathered commissions for NAB financial planning advisors.

The bank decided to extend protections of the code of banking practice to small businesses which are having lower than $5 million in terms of total borrowings. This is an increase from the level of less than $3 million which was previously agreed.

Constant Payment of Dividends Might Attract Investors’ Attention: National Australia Bank has declared the final dividend amounting to 99 cents per fully paid ordinary share (100% franked). The bank keeps on adjusting the Dividend Reinvestment Plan (or DRP) periodically in order to reflect capital position and outlook. In FY 2018, the bank declared total dividend per share amounting to 198 cents which have remained constant from the past few years. Thus, the bank has managed to maintain its dividend pay-out ratio in the range of 79% to 94.1% over the past five years amidst certain challenges within the industry. This reflects that the bank is possessing decent fundamentals which might continue to help in the challenging environment. The bank is possessing an annual dividend yield of 7.91% which is higher than the industry median of 6.6% reflecting that NAB is relatively a better option for the dividend investors. We expect that the bank is likely to continue to have a decent dividend pay-out policy in years to come and reward dividends to its shareholder under any circumstances. This strategy might attract the investors’ attention moving forward.
 

Dividend and Dividend Payout Ratio Trend (Source: Company Reports)

What to Expect from NAB Moving Forward: The important focus of the bank is towards uplifting the capability and innovation in its leading SME franchise. Over FY18, the bank managed to simplify its product offering and, thus, product numbers have reduced from around 600 to lesser than 500.

The bank is expecting cumulative cost savings amounting to at least $1 billion by September 30, 2020 and they are simplifying and automating the processes, reducing procurement and the third-party costs. We expect that the bank’s focus on reducing the costs might help it in strengthening its bottom-line position and might also place it in a better position to respond to the industry-wide challenges. The bank has plans to maintain the strong capital, funding and liquidity positions. The bank is committed to maintaining the well-diversified wholesale funding portfolio which can have access to numerous funding and capital options across markets. The bank also plans to monitor as well as assess the positions in order to accommodate changes in market conditions and regulation.

Stock Recommendation: The stock of National Australia Bank has been delivering decent returns to the shareholders from the past few months. In the span of the previous three months, the stock posted a 7.28% return while, on the YTD basis, it posted a 5.97% return. Also, the bank has been targeting to achieve CET1 of 10.5% by FY 2020 which could further increase the traction among the market players. The bank’s transformation has been ramping up at a decent pace which further builds the confidence in the bank’s expected performance.

Moving forward, the bank is expected to be supported by decent balance position and the higher-than-industry median dividend yield. Also, the prudent management of the costs can also act as a tailwind for the bank’s long-term performance. The bank enjoys respectable financials in terms of improving Group Common Equity Tier 1 (CET1) ratio, decent balance sheet position and paying regular dividends to its shareholders amidst certain challenges. Hence, considering the growth potential in the long run, we have valued the stock using 1-year forward P/BV multiple to FY20E consensus Book Value Per Share (BVPS) of $19.83; and 5-year average P/E multiple to FY20E consensus EPS of $2.4 and have arrived at the target price upside of single high-digit to low double-digit growth (in %).

On the backdrop of the above factors, we give a “Buy” rating on the stock at the current market price of A$25.110 per share (up 0.28% on 28 March 2019).   
 
 
NAB Daily Chart (Source: Thomson Reuters)

 
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