AUSTRALIA NAB AU Price (at 08:23, 03 Jul 2012 GMT) Outperform A$23.68 Volatility index Low 12-month target A$ 27.66 12-month TSR % +24.9 Valuation A$ - DCF (WACC 12.6%, beta 1.0, ERP 5.0%, RFR 5.8%) 25.14 GICS sector Banks Market cap A$m 53,043 30-day avg turnover A$m 163.0 Number shares on issue m 2,240 Investment fundamentals Year end 30 Sep 2011A 2012E 2013E 2014E Net interest Inc m 13,059 13,587 14,005 14,649 Non interest Inc m 4,502 4,674 4,624 4,801 Underlying profit m 9,587 10,318 10,565 11,134 Reported profit m 5,185 6,877 6,078 6,606 Adjusted profit m 5,427 5,729 5,939 6,470 EPS adj 248.0 251.9 255.7 273.4 EPS adj growth % 15.5 1.6 1.5 6.9 PER adj x 9.5 9.4 9.3 8.7 PER rel x 0.79 0.76 0.81 0.83 Total DPS 172.0 183.0 192.0 200.0 Total div yield % 7.3 7.7 8.1 8.4 Franking % 100 100 100 100 ROA % 0.8 0.8 0.8 0.8 ROE % 13.4 13.4 13.3 13.6 Equity to assets % 5.6 5.7 6.0 6.2 EV/EBITDA x -3.3-2.9-2.7-2.4 P/BV x 1.4 1.2 1.2 1.1 NAB AU vs ASX 100, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, July 2012 (all figures in AUD unless noted) 3 July 2012 Macquarie Securities (Australia) Limited Negativity in reverse Event There are good grounds to believe that many of NAB s 1H12 negatives (large UK BDDs, large margin decline, slow business credit) are unlikely to get worse and at best could reverse over the next 6 12 months. Outperform. Impact UK - NAB has done the mea culpa The NAB 1H12 result represented the come clean event for NAB in the UK. This saw the bank announce further impairment on its CRE book, the decision to hive the book off into the Group Centre/SGA and the decision to right-size its UK operations for sale at some point in the future. There remains downside risk. However, we capture this in our numbers, with our effective write-down on the UK CRE book equivalent to c15% of GLA, which we believe to be the right number. Margins NAB has been the most aggressive on repricing and will have more levers heading in to an election year NAB has been the most aggressive in repricing to date across both mortgages (31bp since March) and business lending (18bp liquidity margin). From a longer-term perspective, NAB has the most comprehensive set of levers relative to peers, to counteract rising funding costs going into an election year. This is because we believe the retail banks will find it more difficult to raise mortgage rates out of cycle and in the presence of rising unemployment. Credit growth - Business looking better than housing In the latest APRA stats, business credit is looking healthier at around c9% annualised growth for the last 3 months relative to mortgage credit which continues to slow. Given NAB s strength in the space, we would expect superior growth, all else equal. Provisioning Cumulative write-off analysis shows NAB is covered at similar levels to the other majors except WBC - A slowing domestic economy remains a risk for NAB, given its dominance in SME/Corporate. We would note though that there has been de-gearing over the last 4 years. Similarly, NAB s impaired asset coverage relative to peers is somewhat misleading, given the bank has written off more than peers since the GFC started, despite having a similar level of impaired asset formation. Earnings and target price revision We adjust our margin forecasts up slightly to reflect recent repricing. This sees our earnings move up by 1-2%. Our target price also moves up to A$27.66 from A$26.46. Price catalyst 12-month price target: A$27.66 based on a DDM/PE methodology. Catalyst: 3Q update in August Action and recommendation Upgrade to Outperform. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com/disclosures.
Analysis We believe there is much negativity priced into NAB at current levels but also many reasons to believe the future is brighter for NAB relative to peers. UK - NAB has done the mea culpa The NAB 1H12 result represented the come clean event for NAB in the UK. This saw the bank announce further impairment on its CRE book, the decision to hive the book off into the Group Centre/SGA and the decision to right-size its UK operations for sale at some point in the future. Fig 1 1H12 moves by NAB to address the UK division Source: NAB, Macquarie Research, July 2012 There remains downside risk. However, we capture this in our numbers, with our effective writedown on the UK CRE book equivalent to c15% of GLA, which we believe to be the right number. This equates to roughly A$300m in additional provisioning over the course of the next two financial years. Fig 2 UK Banking Total Provisions to GLA 15% write-down in the UK CRE, brings NAB UK CRE portfolio to 100% coverage 16% 14% 12% 10% 8% 6% 4% 2% 0% 2.4% 2.6% 2.6% Specific Provision to Collective Provision to We have an additional A$310m in our numbers for CRE impairment 2.5% 5.0% UK CRE overlay 4.4% 7.5% 7.5% Total Provision Coverage Partial writeoffs 3.1% 11.9% 11.9% Implied CRE Provisions to MRE additional provision 15.0% CRE Provisions to 3 July 2012 2
2010 Election Macquarie Private Wealth Margins - NAB has been the most aggressive on repricing and will have more levers heading into an election year NAB has been the most aggressive in repricing to date across both mortgages (+31bp since Feb) and business lending (+18bp liquidity margin). Fig 3 Re-pricing April-June 2012, NAB remains most competitive in mortgages Sep11-Mar12 April-12 to current NAB 14bp 22bp ANZ 6bp 19bp CBA 10bp 14bp WBC 10bp 17bp From a longer-term perspective, we believe that NAB has the most comprehensive set of levers to counter-act rising funding costs going into an election year (an election needs to be held before Sept 2013). We believe the banks will find it more difficult to raise mortgage rates out of cycle in an election year and in the presence of rising unemployment. Fig 4 Sector repricing vs. unemployment, historically out-of-cycle repricing reduces in an election year 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% 0.00% -0.05% Banks were quiet during big increase in unemployment Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Source: RBA, Macquarie Research, July 2012 Out of cycle changes Banks also absent in the run up to the 2010 election Apr-10 Jul-10 Oct-10 Unemployment (RHS) This leaves banks with strong business franchises (such as NAB) in a better position to manage margins, in our view. Credit growth Business looking better than housing Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 In the latest APRA stats, business credit is looking healthier at around c9% annualised growth for the last 3 months relative to mortgage credit, which continues to slow. Given NAB s strength in the space, we would expect superior growth, all else equal. 6.3% 5.8% 5.3% 4.8% 4.3% 3.8% 3 July 2012 3
Fig 5 Business lending starting to pick up? 15% 10% 5% 0% -5% -10% Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Housing Lending Grow th (MoM Annualised) Business Lending Grow th (MoM Annualised) Source: RBA, APRA, Macquarie Research, July 2012 Business provisioning Net write-off analysis shows NAB is covered at similar levels to the other majors While a slowing domestic economy remains a risk for NAB, given its dominance in SME/Corporate, we would note that there has been de-gearing over the last 4 years. Fig 6 Gearing (debt to assets) forecast to continue to decline SME Corporate Institutional Apr-08 76.1 72.2 69.3 Apr-09 66.9 64.3 60.6 Apr-10 57.9 56.6 56.9 Apr-11 51.6 52.3 55.8 Mar-12 43.3 51.6 53.8 Apr-13 39.6 50.5 53.2 Source: East & Partners, Macquarie Research, May 2012 Similarly NAB s impaired asset coverage relative to peers is somewhat misleading, given the bank has written off more than peers since the GFC started. Our analysis below highlights this differential. While current coverage is below peers this is not the full story. When examining cumulative historic coverage (provisioning + net write-offs divided by starting impaired assets + cumulative new impaired assets) a majority of the difference disappears for a few reasons. Firstly, NAB has written off more assets. This, all else equal, could be interpreted as an attempt of the bank to clean up its book or could simply be reflective of a poorer quality loan book. On the impaired asset side, NAB has generated slightly more cumulative impaired assets than competitors but not materially so relative to the written-off assets. Hence, we believe the current coverage debate can be partially explained by more rapid write-off trends at NAB. 3 July 2012 4
Fig 7 Current vs. cumulative historic coverage NAB has written more off 120% 113% 100% 94% 93% 80% 79% 78% 60% 48% 60% 55% 40% 20% 0% ANZ CBA NAB WBC Current Cumulative Investment Thesis Margins looking better We adjust our margin forecasts up slightly to reflect recent repricing. This sees our earnings move up by 1-2%. Our target price also moves up to A$27.66 from A$26.46. As a result we move NAB to Outperform. Fig 8 Earnings changes A$ FY12E FY13E FY14E Cash NPAT Old 5,661 5,807 6,333 New 5,721 5,931 6,462 % Change 1.1% 2.1% 2.0% Cash EPS Old 249 250 268 New 252 255 273 % Change 1.0% 2.1% 2.0% Dividend Old 182 192 200 New 183 192 200 % Change 0.5% 0.0% 0.0% Source: Macquarie Research, July 2012 3 July 2012 5
Year Ending 30 September 1H11 2H11 2011 1H12 2H12E 2012E 2013E 2014E Outperform PER SHARE DATA Cash EPS (AUD) - Macquarie Basis 122 126 248 125 126 252 255 273 Current Price Target Price Cash EPS Growth (%) 10% 3% 16% 0% 1% 2% 2% 7% A$23.68 $27.66 DPS (AUD) 84 88 172 90 93 183 192 200 Total Shareholder Return 24.1% BVPS (AUD) 16 17 17 17 17 17 17 17 NTA PS (AUD) 13 14 14 14 14 14 14 15 Bloomberg: NAB AU Shares on issue (m) 2,170 2,201 2,201 2,239 2,263 2,263 2,310 2,359 Reuters: NAB.AX VALUATION METRICS Macquarie Equities Australian Banks P/E (Cash) 9.7 9.4 9.6 9.5 9.4 9.4 9.3 8.7 Analyst(s) Contact(s) P/B (Stated) 1.5 1.4 1.4 1.4 1.4 1.4 1.4 1.4 Michael Wiblin +61 2 8232 6089 P/NTA 1.8 1.7 1.7 1.7 1.7 1.7 1.6 1.6 Stephen Wood +61 2 8237 6043 RoE (%) 13% 13% 13% 13% 13% 13% 13% 13% Elisa Di Marco +61 2 8237 6253 RoA (%) 0.8% 0.7% 0.7% 0.7% 0.8% 0.8% 0.8% 0.8% Dividend Yield (%) 3.5% 3.7% 7.3% 3.8% 3.9% 7.7% 8.1% 8.4% Margins & Volumes Dividend Payout (%) 68.8% 70.0% 69.4% 72.0% 73.5% 72.7% 75.2% 73.2% Net Interest Margin (RHS) Growth (LHS) Sustainable RoE used in Valuation (%) 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 10.0% 2.8% Cost of Equity (%) 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 12.6% 8.0% 2.3% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% 1.8% 1.3% 0.8% 0.3% -0.2% -0.7% 1H11 2H11 2011 1H12 2H12 2012 2013-1.2% Cost/Income Ratio (RHS) Efficiency Cost Growth (LHS) 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 1H11 2H11 2011 1H12 2H12 2012 2013-10.0% PROFIT & LOSS (AUDm) Net Interest Income 6,304 6,788 13,092 6,708 6,879 13,587 14,005 14,649 Non-Interest Income 2,495 2,007 4,503 2,400 2,274 4,674 4,624 4,801 Fees & Commissions 1,679 1,753 3,432 1,626 1,643 3,269 3,342 3,504 Financial Markets 326-112 214 320 22 54 457 475 Life and Funds 811 717 1,529 760 74 1,508 1,504 1,512 Other Revenue -321-351 -672-306 -340-646 -678-691 Total Operating Income 8,799 8,795 17,595 9,108 9,153 18,261 18,630 19,450 Total Operating Costs 3,991 3,983 7,974 3,952 3,991 7,943 8,065 8,316 Employee Costs 2,323 2,240 4,563 2,265 2,310 4,575 4,760 4,952 Other Costs 1,668 1,743 3,411 1,687 1,680 3,367 3,305 3,364 Pre-Provision Operating Profit 4,808 4,812 9,621 5,156 5,162 10,318 10,565 11,134 Impairment Charge 988 834 1,822 1,131 1,039 2,170 2,138 1,952 Pre-Tax Profit 3,820 3,978 7,799 4,025 4,124 8,149 8,426 9,182 Tax Expense 1,066 1,076 2,142 1,121 1,155 2,276 2,353 2,579 Minority Shareholders -1 0-1 -2-2 -4-4 -4 Other Post Tax Items 325 111 436 850 15 1,000 0 0 Stated Net Profit 2,428 2,791 5,220 2,052 2,817 4,869 6,070 6,598 Extraordinary & Other Items -2 111 109 751 15 90 0 0 Hybrid Distributions -114-111 -225-105 -111-216 -216-216 IoRE/Non Controlling Interest 29 1 30 31 37 68 77 80 Derivatives & Hedging Revaluation 327 0 327 99 0 99 0 0 Macquarie Cash Profit 2,668 2,792 5,461 2,828 2,893 5,721 5,931 6,462 74% 72% 70% 68% 66% 64% 62% 60% 58% 56% Asset Quality Impairment Charge (RHS) Coverage (LHS) 80 75 70 65 60 55 50 45 40 35 30 25 20 1H11 2H11 2011 1H12 2H12 2012 2013 BALANCE SHEET & CAP AD (AUDm) Risk Weighted Assets 345,211 341,069 341,069 335,553 336,361 336,361 349,347 368,364 Interest Earning Assets 566,624 594,578 580,601 618,945 633,133 626,039 652,704 692,339 Gross Loans, Advances & Acceptances 459,246 482,125 482,125 490,407 501,648 501,648 524,106 556,074 Total Deposits 458,164 505,226 505,226 517,514 529,377 529,377 553,075 586,811 Total Assets 689,463 753,757 753,757 756,843 759,069 759,069 768,330 793,794 Shareholders Equity 39,820 42,188 42,188 42,555 43,338 43,338 46,199 48,923 Tier 1 Capital 31,738 33,075 33,075 34,113 35,188 35,188 38,598 41,824 Tier 1 Ratio (%) 9.2% 9.7% 9.7% 10.2% 10.5% 10.5% 11.0% 11.4% Core Tier 1 Ratio (%) - Basel II 7.1% 7.6% 7.6% 8.0% 8.3% 8.3% 9.0% 9.4% Core Tier 1 Ratio (%) - Basel III 6.5% 7.1% 7.1% 7.6% 7.8% 7.8% 8.5% 8.9% ASSET QUALITY Impairment Charge / (bp) 44 35 38 47 42 43 41 35 Coverage (%) 64% 62% 62% 64% 66% 66% 72% 81% 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 5.09 Total Stage 1 Dividends DDM Valuation 13.27 6.63 Total Fade Period Total Perpetuity Dividends Dividends 1.19 Total Surplus Capital Per Share KEY RATIOS & GROWTH Net Interest Income growth (%) 2.1% 7.7% 6.5% -1.2% 2.5% 3.8% 3.1% 4.6% Non-Interest Income growth (%) 12.0% -19.6% 3.5% 19.6% -5.2% 3.8% -1.1% 3.8% Total Revenue growth (%) 4.7% 0.0% 5.8% 3.6% 0.5% 3.8% 2.0% 4.4% Cost growth (%) -0.2% -0.2% 1.4% -0.8% 1.0% -0.4% 1.5% 3.1% Pre-Provision Profit growth (%) 9.3% 0.1% 9.6% 7.1% 0.1% 7.3% 2.4% 5.4% RWA growth (%) 0.2% -1.2% -1.0% -1.6% 0.2% -1.4% 3.9% 5.4% growth (%) 2.5% 5.0% 7.6% 1.7% 2.3% 4.0% 4.5% 6.1% Deposit growth (%) 3.7% 9.1% 13.2% 3.2% 2.3% 5.5% 4.5% 6.1% Net Interest Margin (%) 2.23% 2.28% 2.25% 2.17% 2.17% 2.17% 2.15% 2.12% Cost / Income Ratio (%) 45.4% 45.3% 45.3% 43.4% 43.6% 43.5% 43.3% 42.8% 3 July 2012 6
Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 60 100% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 June 2012 AU/NZ Asia RSA USA CA EUR Outperform 55.67% 61.00% 53.43% 42.58% 69.23% 46.60% (for US coverage by MCUSA, 9.05% of stocks followed are investment banking clients) Neutral 30.50% 22.11% 36.99% 52.41% 28.02% 33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients) Underperform 13.83% 16.89% 9.59% 5.01% 2.75% 19.71% (for US coverage by MCUSA, 0.45% of stocks covered are investment banking clients) Company Specific Disclosures: Macquarie Bank Limited makes a market in the securities in respect of Limited. Macquarie and its affiliates collectively and beneficially own or control 1% or more of any class of Limited's equity securities. Important disclosure information regarding the subject companies covered in this report is available at www.macquarie.com/disclosures. Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN 94 122 169 279, AFSL No. 318062) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN 58 002 832 126, AFSL No. 238947) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN 41 002 574 923, AFSL No. 237504) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN 46 008 583 542, AFSL No. 237502) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act 1989. Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. 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