Westpac Banking Is Stuck On My Avoid List

Main Thesis

The purpose of this article is to evaluate Westpac Banking Corp. (NYSE:WBK) as an investment option at its current market price. WBK is a stock I used to recommend (and own), although I shifted away from Australian banks some time ago. However, I kept WBK on my radar because I watch the Australian economy closely, and the dividend yields offered by the banks there offer relatively attractive dividends. As we push forward in 2020, some developments across the continent and within the company itself continue to give me reasons for pause. One, the company has suspended its dividend, which was a primary driver of my interest, to begin with. Two, recent earnings have been quite poor, and the macro-environment suggests a turnaround in the second half of the year will be difficult. Three, unemployment, mortgage delinquencies, and consumer sentiment are all trending negatively. Couple all this with low interest rates, and it will be difficult for WBK to succeed.

Background

First, a little about WBK. The company is a banking organization that provides a range of banking and financial services, including consumer, business, and institutional banking and wealth management services. The company is one of the “big four” of Australian banks and has branches throughout Australia, New Zealand, Asia, and the Pacific. The stock is trading at $12.40/share, and it is not yielding anything at the moment, given the company’s suspension of the dividend. I covered WBK at the end of last year, when I recommended investors avoid the fund. While I was right in this conclusion, hindsight tells me I was not bearish enough, as the fund has performed poorly in the interim:

Source: Seeking Alpha

Given the stark underperformance of WBK, I thought it was time to take another look at the stock, to see if a turnaround may be forthcoming. After review, I continue to believe this is not a stock I should recommend, and I will explain why in detail below.

Short-Term Move Is Very Bearish

To begin, I want to highlight how negative WBK’s performance has been. This is a stock that has very little momentum going for it, despite the fact that it has rallied sharply off its March low. While that was positive, almost all stocks/sectors saw strong gains off their March lows. When we look past the short-term rally and look at the first half of the year, we see the story for WBK is not very pretty. For comparison, I looked at WBK’s year-to-date performance against both the iShares MSCI Australia ETF (EWA), which offers broad exposure to the Australian stock market, and the S&P 500, seen below:

Source: CNBC

My point here is to illustrate that avoiding WBK would have made quite a bit of sense, so I use this as validation that previous assumptions proved correct. Looking ahead, I see multiple reasons to not expect a reversal in fortune, which I will take one at a time in the following paragraphs.

The Dividend Was Cut. Now, It Is Suspended

In my last review, one primary reason for my lack of optimism for WBK regarded the company’s dividend. At that time, WBK cut the semi-annual payout, which concerned me especially as a “Dividend Seeker”. I rarely like the implications behind a dividend cut, and in this case, it was particularly negative because the above-average dividend is a key reason I keep WBK on my radar at all. While U.S.-based banks had been offering low dividend yields for years post-recession, Australian banks offered yields that were two or three times greater by comparison. Therefore, seeing WBK cut its dividend, while U.S.-based banks have now been aggressively raising them, was a clear signal that this was not a stock I wanted to be in when 2020 got underway.

Fast forward to today, and WBK announced the June 2020 dividend would be deferred, with no guidance on when it will be paid, or even if it will be paid. While I was pessimistic about the previous cut, it is fair to see I am very pessimistic on this new development. While I did not like the cut, WBK’s dividend was still high, especially compared to the broader U.S. equity market and U.S. banks. But the decision to suspend the entire dividend is very bearish, as it speaks to cash flow problems and management’s negative short-term outlook. Clearly, management does not expect conditions to improve dramatically any time soon. Otherwise, it would not have been necessary to hold on to the cash that was supposed to be reserved for shareholders.

My takeaway here is this is a very negative development for the company. Until I see clarity on when the dividend will return, and in what capacity, it will be difficult for me to find a reason to buy this stock.

Earnings Report – Not Very Impressive

I now want to take a look at the company’s earnings because this is another point of great concern for me. In a nutshell, earnings were weak, with profit and cash earnings down by a large margin on a year-over-year comparison:

Source: Westpac Investor Centre

Worryingly, these results were impacted by poor performance across the board. In fact, each primary division within the company saw a sharp drop-off in earnings, as shown below:

Source: Westpac Investor Centre

The point here is the company is facing challenges, not just in one particular area, but in its entire business model. Of course, some of the impairment is due to one-time items, such as insurance claims from the infamous bushfires that started last year. But the company continues to be plagued by a difficult economic environment, and its net margins are under pressure due to continued low interest rates set by the Reserve Bank of Australia.

In summary, there was not much to cheer about in the recent earnings report. While investors should be forward-looking, I will discuss next why the macro-environment does not suggest much improvement to WBK’s earnings will be forthcoming. Therefore, I am predicting continued weakness in earnings in the second half of the year, which makes me cautious on the stock, despite its seemingly low price on a historical basis.

I’m Not Counting On A Rebound

Up to this point, I have discussed the general weakness surrounding WBK, but, in fairness, most of this in the past. Investors may figure the future can’t be much worse, and now would be a good time to start positions considering how beat up the stock is.

I would caution against this sentiment, for a few reasons. One, I do not believe the macro-environment is going to get much better any time soon. Australia, like most economies, is struggling with rising unemployment, which is sure to pressure the banking sector. As employees are let go, they will evidently struggle to pay their bills, such as mortgages, credit cards, or other loans. This will pressure profits in the banking sector, as the lending units will likely see a rise in delinquencies. And the rise in unemployment is no small matter. Currently, the unemployment rate sits just above 7%, with a large number of jobs lost during the months of March and April, as shown below:

Source: Bloomberg

Clearly, this is a very negative trend, and it is starting to have broad impacts across the economy. For instance, consumer sentiment has plunged, which is an indication that Australians are not optimistic about their current situations or immediate future. In fact, consumer sentiment is at levels not seen since the 2008-09 financial crisis, as illustrated below:

Source: Reserve Bank of Australia

Of course, this is just sentiment, which can change quickly. But this bad news is this negative sentiment is seemingly well justified, with delinquencies rising across the country. In fact, according to a report from Moody’s Investors Service, the 30+ days delinquency rate for prime Australian residential mortgage-backed securities rose to 1.79% in Q1 2020, up from 1.55% in Q4 last year. This is concerning, because this figure does not factor in April or May yet and shows delinquencies started to rise at the early stages of the crisis. Moody’s predicts this figure will keep rising, which is very plausible. Worse, this crisis has come at a time when the average Australian household was already deeply indebted. While household debt has leveled off in the short term, it still sits at a historically high level, as shown below:

Source: Reserve Bank of Australia

My takeaway from all this is the Australian economy is facing a difficult position, and I see this extending to WBK’s bottom line. The rising delinquency rate is already having an impact on WBK’s financial performance, as the company saw rising delinquencies in its latest earnings report, compared to both the second half of 2019 and on year-over-year basis, as shown below:

Source: Westpac Financial Results

Of course, investors could say this is expected and will improve in time as the economy recovers. While I would agree with that sentiment, I want to highlight that this is a critical risk for WBK. The company’s exposure to residential mortgages is quite high, in terms of the dollar amount, but also in relation to its other business categories. To illustrate, consider that residential mortgages make up over one-third of the firm’s risk-weighted assets, shown below:

Source: Westpac Financial Results

Clearly, this is an area WBK is long, and in the short term, it is a deteriorating asset class. While I expect the bulk of the assets in the sector to exhibit some long-term resiliency, it is clear that more mortgages are falling behind, and the unemployment and debt figures suggest more are going to follow. This will mean WBK will rack up more losses in one of its most fundamental lending areas, which will likely contribute to further weakness in the stock.

Bottom Line

WBK remains on my avoid list. The stock simply faces too many headwinds for me to take on a gamble on it. Before May of this year, it may have been easier to justify a bet on WBK at current levels, because the stock’s high dividend yield would act as a cushion against some short-term weakness. However, that dividend has now been suspended, removing a key reason why I follow WBK. In summary, I see a challenging environment for Australia as a whole, which will make it difficult for WBK to outperform. Therefore, I believe investors should think very carefully before starting a position in WBK at this time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seeking Alpha

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