National Australia Bank’s roadshow in England earlier this month, which was designed to impress the investment community with the progress the bank is making with its UK businesses, has left sell-side analysts with mixed feelings.
While Deutsche Bank’s Ross Brown was impressed by NAB’s story and gave the bank a buy rating and a target price of $46.50 (Friday’s close was $39.76), the consensus view was reflected in the notes issued by Goldman Sachs JB Were and Macquarie Equities, which both put NAB’s valuation a little above the current market price and said there were some long-term gains to be made in the UK market but little in the short term.
The outlier on the downside was JP Morgan’s Brian Johnson, who issued a report on NAB ahead of the roadshow, saying that the UK operations did not make a sufficient contribution to group earnings for any improvement to be meaningful. Johnson put a target price of $34.76 on the NAB’s stock.
NAB was keen to impress with figures for its UK subsidiaries, Clydesdale Bank and Yorkshire Bank, showing growth above system in mortgage and business lending, and business and personal deposits. Analysts acknowledged this performance but were worried by big falls in the net interest margin and the bank’s slow progress in getting its cost to income ratio down to an acceptable level.
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The UK business contributed $324 million to NAB’s $2.2 billion of cash earnings in the March half – about 15% of total earnings. The cost to income ratio was 59% and the net interest margin fell 50 basis points from 3.68% to 3.16%.
Among the highlights were 9.3% growth in mortgages for the March half, compared to system growth of 4.2%, and 19.3% growth in business deposits compared to 4.3% system growth.
Goldman Sachs JB Were analyst James Freeman said the market had been looking for a reduction in the rate of margin decline but he expected margins to continue to decline at a rate of 25 to 30 basis points a year “over the next few halves”.
Freeman said there was increasing regulatory pressure in the UK market, which was having a negative impact on sector earnings. Among the regulatory issues the industry faces currently, Freeman cited a review of credit card fees by the Office of Fair Trading, and an OFT study of the pricing of current accounts, a cap on mortgage exit fees by the Financial Services Authority and a review of the Banking Code.
Freeman said NAB was reporting good loan growth and had significant opportunities to cut costs. His conclusion was that NAB’s improved UK performance made it a good long term buy but no more than a market performer in the short term. His price target for the bank is $42.15.
Macquarie Equities believes NAB is worth $42.80 a share. Its review of the roadshow highlighted the opportunity the bank has to cut costs in its UK operation.
Macquarie’s view is that significant cost savings will be achieved over the long term but that margin pressure remains a problem in the short term. NAB remains Macquarie’s fourth pick among the big four Australian banks.
Deutsche’s positive outlook is based on a view that the margin decline is moderating, and that the bank’s strategy of integrating the back offices of Clydesdale and Yorkshire is starting to achieve results.
JP Morgan speculated that NAB may be about to launch a takeover in the UK to add some scale to its operation there.
If the bank does not get bigger it should get out, JP Morgan says. “NAB holds no competitive advantage in the UK market. We see NAB’s best UK strategy is to exit. With an estimated 61% of all mortgages in the UK being sold by IFAs (independent financial advisers), the agents own the customers. The banks have lost the ability to cross-sell to customers and have become commoditised price takers.”