NAB must deliver surprise to prop up share price

National Australia Bank is under huge pressure to shine on Thursday when it is expected to report a first-half profit result of $3.31 billion in a week dominated by Aussie bank earnings.

That pressure has sharpened considerably by the lender’s Price/Earnings multiple jumping from 11 to 13.5 since last June. With solid cost cuts and a drop in bad debts already factored into the share price, NAB really needs to deliver a major surprise to support the current high share price.

Most analysts are hoping for a hefty cost cut. It makes sense since a highlight of NAB's full year 2016 result was its cost control effort. Expenses grew 2.2 per cent year-on-year but they actually dropped by 2 per cent in the 2016 second half.  

Management said it is aiming for positive 'jaws' and is seeking $200 million of productivity savings - 2.5 per cent of its cost base - from third-party expenses, process automation and its new personal bank origination platform.

"We believe expenses will increase 3 per cent in full year 2017, with scope for a positive surprise,” noted Morgan Stanley’s Richard Wiles, while acknowledging that costs blew out by 5 per cent in the 2017 first quarter.
 

Timing issue  

While UBS analyst Jon Mott called first-quarter cost control disappointing, he put this rise down to a timing issue with redundancies and timing of pay rises.

“We are expecting NAB's cost performance to improve throughout the year with further initiatives likely," he said in a client note.

In addition to an earnings ‘miracle’, investors will want to know how large the lender’s mortgage book has grown and whether the business bank is starting to make strides.

Acording to Wiles, the big question for NAB executives is whether NAB should try to grow its Australian mortgages in line with system. NAB grew below system for much of 2016.

“We don't think system growth should be a key objective for management,” argued Wiles. 

“In 2017-18, NAB should be less affected than Commonwealth Bank or Westpac by the latest round of macro prudential rules, however, competition in its priority segment of 'home owners' is likely to pick up."

Regarding the business bank, he went on to say, while loan growth remains subdued, feedback suggests that margins are stable, fee collection is improving and banker productivity is an area of focus.
 

Risk of dividend cut

NAB's new segmental disclosure revealed that business bank revenue grew 2 per cent in the 2016 second half - on the immediately preceding half - and investors are looking for improved momentum in Thursday's announcement given this division includes 25 per cent of the group's housing loans, which have benefited from re-pricing.

According to Mott, asset quality should remain solid despite the first quarter pick-up in bad debts believed to be Slater & Gordon. To him, low risk-weighted asset growth is also likely to be a highlight as NAB focuses on running down undrawn facilities.

“This should enable solid organic capital generation,” he said. 

Aside from progress with costs and productivity, Credit Suisse analyst Jarrod Martin’s focus is on whether the current dividend payout ratio is sustainable after the bank divested its UK operations as well as most of its life insurance business.

“We forecast a continuation of a flat dividend per-share on the basis that NAB appears to be relatively well-capitalised and prioritises the maximum distribution of franking credits,” Martin added.

If NAB holds the dividend payout ratio steady, this means the payout ratio would still be 79 per cent this year and 78 per cent next year, based on Morgan Stanley estimates.

“We think the risk of a dividend cut remains higher at NAB than at the other majors,” advised Wiles.

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