Rising Funding Costs Will Compress Net Interest Margins In Future

Key Takeaways

• Increased investment in technology and risk management may suppress net margins and earnings short to medium term.
  
• Rising funding costs from customer preference shift and heightened competition may compress net interest margins and earnings.
  
• Strong balance sheet growth, digital investments, competitive mortgage growth, and high customer satisfaction indicate potential for sustained revenue and earnings growth.

Catalysts

Engages in the provision of banking and other financial services to retail customers and small to medium sized businesses in Australia.

• Higher investment spend and increasing operating expenses, particularly in technology and risk management, may suppress net margins and earnings in the short to medium term.
  
• The shift in customer preferences towards higher-cost deposit products, like term deposits and offset accounts, is increasing funding costs, thereby negatively impacting net interest margins and earnings.
  
• Intensified competition in the deposit and lending markets may pressure Bendigo and Adelaide Bank to increase pricing, which could hurt revenue growth and compress net interest margins.
  
• Strategic initiatives to grow business and agri segments and reliance on new broker and digital lending channels could be risky, potentially leading to variability in credit quality and impacting future earnings stability.
  
• The bank's plans to increase wholesale funding to support lending growth could result in higher funding costs, further compressing net interest margins and affecting earnings.

Bendigo and Adelaide Bank Future Earnings and Revenue Growth

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Bendigo and Adelaide Bank's revenue will grow by 4.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from -4.3% today to 24.5% in 3 years time.
• Analysts expect earnings to reach A$542.4 million (and earnings per share of A$0.89) by about June 2029, up from -A$83.3 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 14.2x on those 2029 earnings, up from -73.7x today. This future PE is lower than the current PE for the AU Banks industry at 16.4x.
• Analysts expect the number of shares outstanding to grow by 0.52% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.87%, as per the Simply Wall St company report.

Risks

• Bendigo and Adelaide Bank has experienced the strongest balance sheet growth in many years due to increased demand for both lending and deposit products, suggesting potential for continued revenue growth if these trends maintain momentum.
  
• The bank's significant investments in digital capabilities and lending platforms may lead to improved operational efficiencies and cost-to-income ratios, potentially enhancing net margins over time.
  
• Mortgage growth is running at approximately twice the system growth rate, indicating strong competitive positioning and potential for increased earnings from higher loan volumes.
  
• The bank's resilient balance sheet, with a household deposit-to-loan ratio well above the average of major banks, positions it for sustained balance sheet growth, potentially supporting stable earnings.
  
• Bendigo's customer numbers are growing faster than any other major or regional bank, backed by a high Net Promoter Score, potentially leading to increased revenue as customer needs are met.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of A$10.65 for Bendigo and Adelaide Bank 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$11.5, and the most bearish reporting a price target of just A$9.0.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be A$2.2 billion, earnings will come to A$542.4 million, and it would be trading on a PE ratio of 14.2x, assuming you use a discount rate of 7.9%.
• Given the current share price of A$10.61, the analyst price target of A$10.65 is 0.4% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.