Investment view
NAB’s turnaround continues to gather momentum. NAB offers sector-leading asset growth, the balance sheet remains strong with an ongoing $5bn buyback (~55% complete)). NAB is building a track record of clean/solid result delivery on improved execution/focus.
Highest earnings leverage to rising rates. NAB’s earnings have the highest leverage to any improvement in margins across the major banks. NAB has guided to 2bps of margin improvement for every +25bps on the cash rate. Improved margins are now more important to earnings growth than NAB’s ongoing restructuring program. NAB’s turnaround momentum offset by falling house prices: Despite the strong operational performance, falling house prices create a headwind for NAB’s share price. We see the prospects of a ~10% fall in national house prices over the coming 12-18 months. In almost all ten periods of falling house prices over the last 40 years, bank shares have struggled to outperform the market.
Valuation multiples at risk of contraction. In this cycle, bank earnings are not likely to be as vulnerable to higher rates given our expectation of margin improvement, low bad debts, and healthy sector provisioning. Earnings multiples are vulnerable. A 2-3x point reduction in NAB’s PER would match prior episodes of RBA rate hikes witnessed since the 1990s. Under this scenario, NAB would be trading at PER of 12-13x. This would imply a NAB share price of ~$25.00.
Hold Recommendation. We see rising interest rates and falling house price concerns as offsetting NAB’s continued strong operational performance. We would become more positive on NAB in the mid $20s. Dividends and capital management are likely to form the main component of total return from NAB over the next 12 months.
Risks to investment view
Upside risks relate to mortgage repricing and stronger than expected levels of credit growth. Key downside risks include further deterioration in interest margins, intensifying lending competition, material slowing in credit growth, delayed resumption of dividend growth, and poor execution of the turnaround strategy. A significant and rapid fall in house prices driven by higher interest rates would present a risk to the share price.
