NAUBF - National Australia Bank: Mixed Results And Murky Outlook

2023-05-09 11:15:29 ET

Summary

• National Australia Bank Limited's first half FY 2023 financial performance was mixed, considering both below expectations net operating income and above expectations net profit.
• The outlook for National Australia Bank is murky, taking into account the high probability of an increase in shareholder capital return and earnings downside risks relating to employee compensation.
• I retain my Hold rating for National Australia Bank in view of the bank's mixed interim results and murky outlook associated with capital return and operating costs.

Elevator Pitch

My investment rating for National Australia Bank Limited (NABZY) [NAB:AU] stock is a Hold.

I deemed National Australia Bank's shares to be fairly valued as per my earlier article for NABZY published on February 23, 2023. With this latest update, my attention turns to the review of National Australia Bank's recently announced interim results for the first half of fiscal 2023 (YE September 30). I have a neutral view of the bank's performance for the recent interim period. Looking ahead, positive expectations of an increase in shareholder capital return are offset by risks relating to higher employee compensation costs. As such, I maintain a Hold rating for National Australia Bank.

Readers should be aware that National Australia Bank's shares can be traded on either the Australian Securities Exchange with the NAB:AU ticker or on the OTC market with the NABZY ticker. As per S&P Capital IQ data, both National Australia Bank's OTC shares and Australian shares have reasonably good trading liquidity with three-month mean daily trading values of approximately $2 million and $100 million, respectively. Investors who prefer to trade in the relatively more liquid Australia-listed shares can rely on brokerages providing international equities market access like Interactive Brokers.

Headline Numbers Show A Mixed Picture

National Australia Bank disclosed the company's 1H FY 2023 financial performance last week on Thursday, May 4.

Net operating income for NABZY, which is the summation of the bank's net interest income and other operating income, grew by a strong +19.3% YoY from A$8,828 million in the first half of fiscal 2022 to A$10,529 million for the recent interim period. But National Australia Bank's actual 1H FY 2023 net operating income turned out to be -2.2% lower than the sell-side's consensus forecast of A$10,762 million as per S&P Capital IQ data.

Prior to the interim results announcement in the prior week, the analysts were expecting National Australia Bank to report a net interest margin of 1.80% (source: S&P Capital IQ ) in 1H FY 2023. But the bank's actual net interest margin for the recent interim period came in -3 basis points lower at 1.77%. This was the main reason for National Australia Bank's top line miss for 1H FY 2023. In its recent semi-annual results announcement , the bank explained that "home lending competition and higher funding costs" led to National Australia Bank reporting below-expectations net interest margin.

But National Australia Bank's actual 1H FY 2023 net income attributable to shareholders amounting to A$3,967 million came in +2.7% above the analysts' consensus estimate of A$3,864 million (source: S&P Capital IQ ). Also, the bank's +11.7% bottom line expansion in YoY terms for 1H FY 2023 was superior to its earnings growth of +5.8% and +10.7% for 2H FY 2022 and 1H FY 2022, respectively.

National Australia Bank's bottom line benefited from good expense control. The cost-to-income ratio for the bank decreased from 44.9% for 1H FY 2022 and 45.5% for 2H FY 2022 and to 42.0% in 1H FY 2023. At the bank's 1H FY 2023 earnings briefing , National Australia Bank revealed that it had realized "productivity savings of $142 million" in the first half of the current fiscal year relating to "simplification" and "process improvements."

In summary, NABZY reported a mixed set of results for the most recent interim financial period. National Australia Bank's net operating income was below the consensus forecast due to lower than expected net interest margin, while the bank's earnings beat was driven by cost optimization initiatives.

There Is A Good Chance Of Higher Shareholder Capital Return

National Australia Bank's Common Equity Tier 1 or CET1 ratio improved from 11.5% as of September 30, 2022 to 12.2% as the end of March 2023, as indicated in its 1H FY 2023 earnings presentation slides. This has exceeded the bank's CET1 ratio target of 11.0%-11.5% as per the company's management comments at the recent interim results call. In other words, National Australia Bank is in the position to consider returning a greater proportion of excess capital to the company's shareholders.

The bank's dividend payout ratio for 1H FY 2023 was a decent 64.1%. Notably, National Australia Bank emphasized at the company's 1H earnings call that its actual dividend payout ratio for the recent interim period was "slightly below the target range (65%-75%) for our dividend payout policy, reflecting a prudent approach in the current environment." Separately, National Australia Bank also mentioned at its recent results briefing that the bank will "reconsider it (share buybacks) over the next quarter" after temporarily halting repurchases in the name of prudence.

In my opinion, the bank is likely to raise its dividend payout ratio for 2H FY 2023 to 65% or higher and resume share repurchases, taking into account its management commentary and strong robust position.

But Employee Compensation Is A Key Downside Risk For NABZY's Future Earnings

In its 1H FY 2023 results presentation, National Australia Bank outlined its goal of achieving a lower "Cost to Income ratio for FY23" as compared to fiscal 2022.

For the first half of this fiscal year, personnel expenses accounted for more than half, or 58% to be specific, of National Australia Bank's total operating costs. This implies that the change in employee compensation costs is the most important factor influencing the bank's future operating expenses and profitability.

National Australia Bank disclosed at the bank's recent 1H FY 2023 earnings briefing that "we're in the middle of a conversation with the union on our enterprise agreement for this year now." Considering inflationary pressures, it is realistic to expect that National Australia Bank is likely to accept a meaningful increase in employee compensation when the discussions with the union are concluded. This poses significant downside risks to the bank's earnings for 2H FY 2023 and full-year FY 2023.

Closing Thoughts

A Hold investment rating for National Australia Bank Limited is justified. The bank's recent interim results and prospects associated with expenses and capital return send a mixed message, which doesn't support a clear Buy or Sell rating for National Australia Bank Limited.

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