Competitive Pressures And Cost Challenges Loom But Calculated Investments Could Bolster Long-Term Growth

Key Takeaways

• Intense competition and changed deposit mix are compressing net interest margins, challenging revenue growth.
  
• Rising tech costs and projects like UNITE increase expenses, negatively impacting short-term earnings.
  
• Westpac's robust financials and strategic tech investments suggest sustained revenue growth and enhanced profit margins amid stable credit quality and customer service focus.

Catalysts

Provides banking and other financial services in Australia, New Zealand, the Pacific Islands, Asia, the Americas, and Europe.

• Intense competition in the consumer banking segment, particularly in mortgages, is putting pressure on net interest margins, which is expected to compress net margins further in the future.
  
• Rising technology costs and investments in projects like UNITE have significantly increased operating expenses, which are expected to continue growing. This could negatively impact net margins as cost growth may outpace revenue growth.
  
• The UNITE program, intended to simplify systems and improve processes, requires significant investment without immediate returns, potentially affecting earnings in the short to medium term.
  
• The transition from call to term deposits in response to rising interest rates has changed the deposit mix, which might be less favorable for net interest margins and could influence revenue outcomes negatively.
  
• With predictions of a sluggish economic recovery and subdued consumer spending, revenue growth may remain constrained, affecting overall earnings potential.

Westpac Banking Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Westpac Banking's revenue will grow by 4.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 33.2% today to 29.9% in 3 years time.
• Analysts expect earnings to reach A$7.1 billion (and earnings per share of A$2.08) by about November 2027, up from A$7.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.2x on those 2027 earnings, up from 15.5x today. This future PE is greater than the current PE for the NZ Banks industry at 13.0x.
• Analysts expect the number of shares outstanding to decline by 0.3% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.05%, as per the Simply Wall St company report.

Westpac Banking Future Earnings Per Share Growth

Risks

• Westpac's strong financial performance, with a statutory net profit and disciplined margin management, suggests stability that can support revenue and earnings growth.
  
• The bank's robust balance sheet, including a high CET1 ratio, provides a cushion for potential external shocks, which could maintain steady earnings.
  
• Strategic investments in technology and initiatives like UNITE are expected to improve efficiency and could enhance profit margins over time.
  
• Improving customer service and innovation in areas like merchant services and digital banking can drive revenue growth across various segments.
  
• Successful management of credit quality and low impairment charges demonstrate resilience, which may sustain net margins and overall financial health.

Valuation

• The analysts have a consensus price target of A$27.51 for Westpac Banking based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of A$33.0, and the most bearish reporting a price target of just A$20.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be A$23.7 billion, earnings will come to A$7.1 billion, and it would be trading on a PE ratio of 16.2x, assuming you use a discount rate of 7.1%.
  
• Given the current share price of A$31.51, the analyst's price target of A$27.51 is 14.5% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.