Having concluded that their net interest margins (NIM) are leveraged to higher rates, Goldman Sachs has upgraded Bendigo and Adelaide Bank (ASX: BEN) and Westpac (ASX: WBC) to Buy from Hold with both banks having entered the broker’s coveted conviction list.
To reflect a more supportive deposit pricing environment, Goldman’s now has sector NIMs rising by 10 bp in FY23 (previously 4 bp), and then 3 bp in FY24 (previously 3 bp), with the broker’s trough to peak system margin assumption for the sector now 13 bp (previously 7 bp).
While Bendigo was up 1.36% at the open, Westpac opened around -1% lower.
Despite higher expenses, the broker's revised sector earnings per share (EPS) forecasts for FY22, FY23, and FY24 sit between -1.5% and 8.8%, 5% above Visible Alpha consensus on Pre-provision operating profit (PPOP).
In addition to higher NIMs, much of Goldman’s revised earnings are attributed to year-over-year system housing credit growth, extended strength in commercial volumes, an average of 4% expense (ex-large/notable items) growth in FY22, FY23, and FY24.
Overall, the broker also expects bad and doubtful debts (BDD) to remain low in the second half of 2022.
Goldman’s $26.12 target price on Westpac implies a 28% 12-month total shareholder return.
The broker believes Westpac provides strong leverage to rising rates and will particularly benefit from the relative lack of domestic deposit repricing witnessed since recent rates cash rate rises.
The broker also expects the bank’s shorter-dated replicating portfolio - three-years for deposits versus five-years for peers - to reap the benefit of higher rates playing through its NIM quicker than peers.
Goldman’s expects the inflationary environment to make Westpac’s $8bn expense target by FY24 unachievable.
However, the broker’s like-for-like FY24 expense forecast of circa $8.9bn still implies an -18% reduction in reported expenses versus 1H22 annualised, and a -7% reduction in expenses, (excluding large/notable items and the impact of potential asset sales).
“On our revised forecasts and target prices, [Westpac] now offers the most upside of the banks over the next 12 months,” the broker notes.
“Beyond this, we note the stock is trading at a 20% discount to peers, versus the historic average 2% discount.”
Goldman’s $11.89 target price implies a 21% 12-month total shareholder return.
The broker believes Bendigo’s volume momentum is strong and improving, growing at 1.5x mortgage system over 12-months, and 2.2x over the last three months.
Given Bendigo’s overall higher exposure to deposit funding, and higher exposure to rate inert deposits, Goldman’s believes the bank provides the best exposure of the banks to rising rates.
The broker also expects more aggressive cash rate hikes to flow through Bendigo’s P&L quicker than peers, especially given the bank does not replicate its exposure to higher rates.
“[Bendigo] has exhibited better discipline than its regional peers on deposit repricing in the face of higher cash rates, which should also support its NIM performance… We also expect [Bendigo’s] PPOP performance should be supported by its discipline on expenses,” the broker notes.
“…with an estimated over-the-cycle loss rate of just 15 bp, versus 22 bp on average for the major banks. This leaves it well-placed should the macro environment deteriorate more than what is currently implied by our forecasts.”
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