Stocks In Focus: Westpac, June 18 2025

0:10Welcome to Motley Fool, Stocks in Focus, our weekly series where we unpack it under the bonnet of a company that's either in the news, widely held, big and well-known. We try and tell you a little bit more about some of the businesses you probably know on the surface, but might want to know a little bit more about. And of course, we use the absolute excellence of the Motley Fool investment team to do that. Today, I'm joined by one such expert analyst, Benny O. Benny, g'day. G'day, it's good. How are you doing today? Mate, I'm very, very well. We're very lucky to have you telling us about Westpac, the business that was once the Bank of New South Wales, then the Wales Bank.

0:45You're too young to remember that one, mate, but I am not, unfortunately. Now, of course, known as Westpac. Now, people probably know the W, I'm sure they do. They kind of think they know what Westpac is and what it does, but your expertise will help us get a little bit deeper into the business. Tell us about Westpac, if you will. Yeah, of course, Scott. So, you mentioned, obviously, Bank of New South Wales. It's actually Australia's oldest bank and first company, founded in 1817. And it did rebrand to Westpac around the 1980s. That's when it merged with the Commercial Bank of Australia. What it does, like all the other big four banks, it's a full-service bank providing everyday needs, home loans, business finance, institutional banking.

1:27You've got a bit of wealth and insurance as well, but it's serving around 13 million customers across Australia and New Zealand now, so quite big and large, obviously, in the big four banks now. But they've got five core divisions. You've got your retail bank, which is consumer. You've got your business and wealth division. You've got your Westpac Institutional Bank, Westpac New Zealand, and you've got the group services. This normally encompasses your treasury functions, your HR, tech, ops, risk. But it's got a house of brands. I already mentioned that it's got the Westpac brand. It's got St.

2:01George brand, Bank SA, Bank of Melbourne, where in Victoria I live. You've got Rams, which is the mortgage franchise, but they're winding down that business. And you've got the BT Wealth division as well there. How banks typically make money? For Westpac, roughly three quarters of revenue comes from the interest margin on the loans that are funded by deposits. What I mean by that is it's the difference between what it pays on deposits and what it charges on loans. And the banks call it the NIM, which is a net interest margin, and that's a key profitability measure for banks. And if you think about it, the easier, the wider the margin, the better.

2:41And that's typically the case. Yeah, making more money is always a good thing. And they have funny ones, mate. The banks are probably, I think, because their inventory is money, it kind of makes some of these metrics a little bit harder to use. Revenue, what is revenue? If you have the assets, it's an asset, it's a customer liability. And like anything, our asset is their liability and vice versa. So it's a little bit hard to get your head around, but you've done a nice job spelling it out for us. Of course, most people don't remember that our big four banks pretty much colonized New Zealand in terms of banking services as well between the four of them.

3:08It has been an interesting story, and I like the house of brands you kind of mentioned. By the way, less said about Rams, the better. I think as we record this, there are some issues with the corporate regulator we probably don't go into, but suffice to say, Westpac probably happy they're winding this business down already. Mate, let's then go from the business itself to the investment case, because as we know, Very rare for a bad business to be a good investment, but it's very possible for a good business to be a bad investment. Big isn't enough. Tell us about Westpac, but specifically, why would an investor consider an investment in one of Australia's big four banks in Westpac?

3:42Probably the first thing they'll point to is that Westpac's balance sheet, it kind of remains in this kind of sound position still. Obviously, it's gone through the rate hikes, and now it's gone through the rate cycle that's going down. But its capital position actually still remains quite healthy. Bayer Ratio, which is Common Equity Tier 1 Ratio, that kind of stands around 12.2%. And the regulatory minimum is around 10.25%. So it's got$9 billion above that kind of minimum. So in a very healthy position. In conjunction, you've got the funding and liquidity levels that remain very strong. LCR, NSFR, these are acronyms for liquidity coverage ratio and net stable fund ratio.

4:23So very jargony words, but essentially these are kind of capacity for the bank to meet their short-term obligations and kind of maintain that long-term funding. Credit losses remain low. You've got$5 billion in provisions. But one thing I want to point to is that Westpac's got a really sticky deposit franchise. Think of those customer deposits like transaction accounts, your savings accounts and term deposits. They fund around two-thirds of Westpac's balance sheet. and that's higher than ANZ and NAB and only slightly behind CBA. But I think that really supports that kind of strong deposit to loan ratio, which banks really love to talk about.

5:02Why this really matters for investors is that having worked at a deposits business at a bank, deposits are a very attractive source of funding for the banks because they're usually really sticky and they're cheaper. And so if Westbrook has a really high deposit to loan ratio, it kind of highlights its loan book is well-funded, it's stable. And I think that's very attractive for both regulators, but also for investors. Secondly, I think not only is deposits growing, their lending is growing, particularly in the areas that the CEO and the executive team are targeting. In the latest half year, business lending and institutional lending, they both grew around 14 % to 15 % respectively.

5:48And before taking up the CEO role, the CEO is actually named Anthony Miller. He was actually previously leading the institutional business as well as the business and wealth division. And both these divisions have been stand-up performers in recent times. And he's clearly stated his role is to target these kind of higher return segments, particularly in business lending, which they typically have high margin products, like your small business loans, your trade finance loans. And these are areas that are growing double digits. The last point I want to make is that I haven't mentioned this yet, but Westpac's simplified the bank through cost-cutting programs.

6:24And they named this program called the Unite program. And what this program is trying to do and achieve is to reduce the number of products by over 70%. They're trying to simplify it over 700 processes. and it's pretty much trying to rationalize its bank, all the school branches, all the IT systems. And management says the Unite program can save around$120 million per year from simplifying mortgages alone, save around$300 million from consumer app consolidation. So if WestFact can complete this kind of tech overhaul initiative, particularly on time and on budget, it's got the potential to unlock margin gains and help cost gains as well.

7:04So I think these are the three main reasons I'd probably like to point to the investment case for Westpac. Tell you what, when you can save$400 million, it shows you how big the bank is, right? Most businesses would be happy to get$400 million in revenue, let alone have costs that they can save of that sort of volume. It just goes to show how big the banks are. And by the way, Matt, that jargon, really useful, Matt. That's why we've got you here because you throw the acronym soup at a lot of people and who knows what it means. You've broken it down beautifully. Motley Fool Money. For more, subscribe to the free newsletter at fool.com.au forward slash listener.

7:37Let's go to the cons case, right? Let's consider why an investor mightn't make an investment. Before I do, I just want to remind people, we're giving general advice, you're not personal advice. Now, we're not going to give a formal recommendation either, but this is at a point in time based on Billy's assessment of the business. He's a smart guy, very good analyst, so I'm pretty comfortable with his assessment. But more broadly, it may well change in time. Why? Because data changes, price changes, circumstances change, and holding our opinions unvaried would be silly. So, So yeah, general advice only and at a point in time.

8:05We're going to do the pros and the cons. We'll ask Ben at the end to maybe have a guess at where the market might take Westpac from here. But in the meantime, mate, throw us those cons. What should an investor just be careful of when it comes to potentially investing in Westpac shares? So I think one of the big ones that a lot of investors are probably looking towards is the net interest margin dimension. And that kind of margin has continued to slide over the last decade and so for Westpac. Its core nim slips to around 1.8 % in the recent results, in the half-year results, and that keeps drifting lower.

8:39We've got fierce competition in mortgages. You've got aggressive term deposit pricing, and all of this is compressing spreads and margins. Also, Westfac is losing share in mortgages as well, and it's got a very big book. I mentioned a sticky customer deposit franchise. It's a big book of ad-call deposits. It makes it kind of very sensitive to the rate cuts, which the RBA is expected to cut further down in this year. So that means that margins potentially may fall faster when the RBA eases. Secondly, I mentioned about that Unite program. It's a massive program transformation and there's execution risk involved.

9:16And so that means there's potential cost blowouts. So management is currently accelerating that kind of transformation spend. It recently spent around$250 million in the first half and it's expected to spend around$400 million in the second half. And there's still around 40 % of the budget that's earmarked for FY26 and FY28. So having worked in bank again, you see these large kind of bank transformation programs. They're very notorious for running over budget and those are running over time as well. So you've got these very legacy systems. You've got product complexity. You've got a new leadership team as well.

9:53The CEO is recently appointed, but he's building his bench of executive team. So he's been poaching a lot of new executives from other banks. So they're quite new within the Westpac realm. So all of this kind of hires the chance of delays and potential overspend. Thirdly, I think I'll point to, and this is more generalizing for a lot of banks, is it's a very cyclical business. Right now, we've got household debt that's sitting nearly twice disposable income. And if unemployment jumps or house prices fall, you've got more borrowers missing repayments. And that could mean bad debts for Westpac spiking up.

10:31And that's just at a time when collective provisions are obviously drifting down. So that's one thing to keep point of. And on top of that, you've got ongoing regulatory headwinds. You just briefly mentioned about the Rams piece, but they've also imposed a billion-dollar capital penalty to Westpac in 2019. And that's due to kind of the poor risk management and governance involved, particularly around the anti-money laundering breaches. recently i think it was last year they had that one billion dollars cut in half so there's still a 500 million dollar um i guess a capital penalty um so that's something to be wary of you got things like in the wholesale funding market you've got this thing called hybrids at1 hybrids they're phasing that out so that could raise the kind of capital position and targets for the banks and and all these kind of regulatory pressures could impact dividends uh slow down buybacks cap the flexibility to raise capital as well.

11:31So it's doing this at precisely the wrong point in the cycle. And I think to top it all, to top it all, is probably around the valuation. It might be, I think it seems a bit rich with limited upside potential. Westpac's trading around 17 times cash earnings per share and it's 1.8 times price tangible book value. These values are above its 10-year average and is also at the top end of global peers. So in my view, I think growth outlook seems quite modest. You've got margin pressures. You've got strong competition in deposits. And you've got mortgage share loss from Westpac. So I think all of this kind of means that there's little room or limited room to grow into that multiple.

12:12Which I think might answer my last question. Until you said that, I wasn't sure which way you were going to lean. But I'm going to ask you to put the crystal ball out front of the desk. And let's look five years into the future. I'm not going to ask you for a formal recommendation. We don't have a view on Westpac at full at the moment, at least not formally. But what do you reckon the odds are of it beating the market over the next five years? It sounds like you're going to say slim. Am I right? Well, it's got a lot of pros and cons I mentioned already, right? So it's undergoing this multi-year efficiency initiative and program, but there's potential for cost flow-outs and running over budget.

12:45But it's got a very sticky deposit franchise, a healthy, sound balance sheet, but the valuation is quite rich. And I mentioned that there's lower mortgage growth and plus there's a new management team involved as well. So I think all of this points to kind of ongoing NIM pressures, so limited upside potential and more downside risk as well. So I think for these reasons, I think Westpac is probably difficult from here to beat the market over the next 5 to 10 years and probably at best at market returns. Very good. That's a great tour through Westpac, mate. Thank you for unpacking that for us. really complex businesses as the Unite program itself shows.

13:24But you've done a wonderful job breaking down and explaining it to our viewers. By the way, our listeners as well, this is the one YouTube video, our Stocks in Focus series that is both on YouTube and on the Motley Fool Money podcast. Now, if you're on the podcast and you want to come over and maybe you have a bit more from the Motley Fool, don't leave the podcast. Stay there. But also subscribe to the Motley Fool's YouTube channel. Just Google Motley Fool Australia YouTube. You'll find it. It's really easy to do. It's youtube.com forward slash foolau. If there's somebody who wants to type it into the browser.

13:52And make sure while you're there, by the way, you subscribe, like, notify, all that kind of good stuff. If you're watching this on YouTube, you haven't checked out the podcast yet, jump onto Motley Fool Money. We're publishing it with Listener. There's two Motley Fool Moneys. There's an American one, and ours here in Australia. You want the Australian one. And lots of great content every single week. Benny, thanks for sharing your expertise with us. Thank you for breaking down Westpac. Fools, thank you for watching. Thank you for listening. Thank you for being part of our Motley Fool community.

14:15Until we speak again, thanks. and full.