Essay: Analysis Of Australian Banking Industry: Top-Down & Bottom-Up Approach.

In groups of 3-4, students should choose firstly an industry and secondly two (2) ASX listed companies in this same industry upon which to undertake a fundamental analysis. 

Fundamental Analysis seeks to identify factors that are likely to influence directional changes in the value of a company and hence its share price. These factors may be macro or micro in context. 

a) Conduct a Top Down analysis of the overall economic environment and consider how forecast changes in economic fundamentals will impact on the performances of companies in the industry your group has chosen. Consider questions including, but not limited to: What is the current interest rate? What is the current value of the $AUD? What is current GDP? What is the inflation rate? What business cycle is the economy currently operating in? 

b) Conduct a Bottom Up analysis of companies' current financial situation. Consider accounting ratios and measures of a firm's performance, how these need to be compared to the industry and company history, • All of the required information for calculation and often the actual ratio/number can be found on various websites on the intemet http://www.investsmart.com.au/ 

Note: When your group is performing the fundamental analysis take a less is more approach. Select a few key performance measures then define each measure; explain what the measure is supposed to show and then what it is showing for the industry/your companies. 
Refer to both your textbook and information available on the imam. This assignment involves research to finding the information and then analysing this resulting information. 

When writing the report, imagine that your audience are people that know nothing about finance or the financial markets. At each stage you will need to carefully explain what do are analysing and why. Do not think that just because your lecturer will know what this ratio means that you do not have to define it. 

Top-Down Approach

Australian Banking Industry is the most profitable and competitive sector. Besides, Australian banking industry is one of the largest portions of the country’s financial systems. The industry comprises of around 147 authorized deposit-taking firms that collectively hold about 55% of assets in the Australian financial firms (Investing.com 2018). The industry has a strong regulatory systems and is dominated by four main financial institutions; the National Australian Bank, the Westpac Banking Corporation, Commonwealth Bank as well as the ANZ. In this case, two banks would be analyzed; that is Westpac Banking Corp and National Australian Bank. Westpac Banking Corp also referred to as Westpac is the Australian financial and banking-service provider whose headquarter is in Sydney (Investing.com 2018). In fact, it is amongst the big four financial institutions operating in Australia. The bank has approximately 14 million clients and has employed around 40,000 individuals. It core business include business banking, consumer banking, BT financial group, ATM alliance, banking alliance for the women as well as pacific banking among others. In other words, Westpac is the largest financial institution in Australian and largest financial banks within New Zealand. The institution offers a wide range of financial and banking services in Australia that include retail banking, institutional banking as well as wealth management services. Having been established in the year 1817, Westpac has been the first financial institution established within Australia. The bank has increased in strength and currently the bank has market cap of over $69.5 billion and the total assets of over $618.3 billion (Investing.com 2018).

On the other hand, NAB is amongst the big four Australian banks in terms of customers, earnings and market capitalization. It was ranked twenty first largest financial institutions across the world in terms of market cap and forty one largest financial institutions across the globe in term of total assets. The bank operates 4,412 ATM across Asia, New Zealand and Australia service around 12.7 million clients (Investing.com 2018).

The top-down approach begins with analysis of the macroeconomic aspects, then performing more particular industry and company analysis and only after one perform fundamental analysis of the particular organization. Basically, the top-down approach looks at overall view of an economy and analyses details of the smaller gears. In essence, investors using the top-down approach start with analysis of the overall economy and then examine trends within the economies which they think would have best chances (Wirsch 2014). This is usually the opposite of the bottom-up analysis that focuses more on key performance and fundamental indicators. With this considerations, the top-down analysis of the economic environment in which the two firms operates would entail analysis of Australian GDP growth rate, its inflation rate, the $AUD exchange rate, the business cycle as well as interest rates.

Australian GDP Growth Rate

Australian economic growth is entering its mature phase. Two years down the line the country’s economy was in its prime. The economic growth was around 4%, which was attributed by the rising house prices, population growth, the burgeoning construction as well as the strong terms of the trade (Focus Economics 2018). Nonetheless, the economic or business cycle is over the hill, the drivers of the demand are currently mixed. Housing market has also cooled and the consumer outlay has slowed. Though there is positives since terms of trades within the country is strong and the government expenditures are also stimulatory (Amaded 2018). The mixture shows that the business cycle within the country would age gracefully instead of expiring suddenly.

The GDP is the commonly employed indicator of an investment climate in a given country. It is usually the best benchmark in comparing a good number of countries. In fact, it is a good measure of the country’s economic growth that is why a good number of the investors utilize it. In this case, Australia is experiencing middling GDP growth rate and its economy is experiencing pains and aches on supply side as the capacity constrains begins to bite. For instance, organizations are having hectic time finding employees (Trading Economics 2018). Consequently, there is a probability that wage would growth and the non-tradables inflations is slowly picking-up. Nonetheless, the low inflation rate has been the main feature of current economic cycle. The chief aspects driving the low inflation rate are still in existence and there is high probability that inflation would remain lower compared to RBNZ (Daily FX 2018).

The GDP is said to have grown to around 2.6 % in the year 2016, which is the fastest in over a decade, though it slowed to around 2.2% over the year 2017. Nonetheless, the country GDP is projected to accelerate by end of this year to around 2.9%. The dynamic growth in Australian GDP is attributed by increase in the demand for the raw commodities from the less developed nations since early 2000s that resulted in strong rise in the global commodity prices and in turn dynamic growth in the country GDP (Trading Economics 2018).

Australia inflation rate is said to move from 2.8% in 2013 to as low as 1.7 in the year 2015. This rate continued to decrease to as low as 1.5 in 2016 but is reported to have increased slightly to 1.9 (Trading Economics 2018). To be more specific, inflation rate for the country was around 2.1% in second quarter and remained close to lower bound of between 2 and 3% range by July and by August. Nonetheless, the RBA projects the inflation rate to be below around 2% by September as a result of one-off decrease in some of the administered prices (RBA 2018). Reserve Bank of Australia is said to leave cash rate or interest rate unchanged at all-time low of around 1.5% where it used to be two years down the line. This move is said to be in line with the market expectations.

Inflation Rate

This approach mostly centres on analysis of the individuals stock. In essence, under bottom-up analysis, investors focus on a particular firm instead of industry in which the firm operates or on whole economy (Liedl & Weg 2011). In this case, the bottom-up analysis of the two banks would entail financial ratio analysis of the banks as well as their financial statement analysis.

Financial ratio analysis has been one of the techniques in examining financial performance of the two banks. According to Kent (2014) ratio analysis is significant in forecasting future success of any firm. In this case, the most acceptable ratios to be used in evaluating Westpac and NAB financial position include profitability ratio such as net margin, the ROE, EPS, ROA and P/E ratio and the solvency ratios including debt to equity ratio. Ratio analysis would be used in revealing strength and weakness of the two banks (Liedl & Weg 2011). Through ratio analysis of NAB and Westpac, this report examines the weakness and strength of these firms and reveals extent the banks have been capable to offer some values to their shareholders.

Based on the analysis, NAB net margin in the year 2017 was 31.23%. This value was slightly lower compared to the industry value of 34.79% (Investing.com 2018). Nonetheless, despite the fact that NAB net margin is lower than the industry value, the value is relatively high and positive meaning that the company has been profitable enough. The net margin for Westpac on the other hand in 2017 was 36.88% compared to 34.55%. The high net margin by Westpac is a good sign that the company has profitable in its operations.

Based on the analysis, it is evident that NAB ROA in the financial year 2017 was 0.78%. The value is almost as per with the industry value. This means that NAB has been effective in utilizing its assets to generate income. On the other hand, Westpac ROA in the year 2017 was 0.97% which was higher than the industry value of 0.92% (Investing.com 2018). The high ROA for Westpac is a clear sign that the company has been efficient enough in utilizing its assets to generate some income.

NAB ROE by September 2017 was 11.73%.  The value is lower than the industry value of 15.5%. Despite the fact that the value is lower than industry value, it can be indicated that the company has been utilizing its shareholders’ equity effectively in generating income. On the other hand, Westpac ROE in the year 2017 was 14.56% slightly below the industry value of 15.5% (Investing.com 2018). Besides, the positive value in Westpac ROE is a clear sign that the company has been utilizing its shareholders’ equity effective in generating some income.

Interest Rates

NAP EPS ratio in the year 2017 was 2.28. This ratio was slightly lower compared to industry value of around 3.62. In spite of the value being slightly lower, it can be stated that NAB is able to generate higher earnings for every share invested in (Investing.com 2018). On the other hand, Westpac EPS for the year 2017 was 2.38 compared to industry value of 3.62. This value shows that Westpac has been paying relatively high amount of earnings per share over the period.

From the analysis, NAB P/E ratio in the year 2017 was 12.98%. This value was relatively higher compared to the industry value of 12.3% meaning that NAB has been able to generate positive earnings for its shareholders. On the other hand, Westpac P/E ratio in 2017 was 12.05% compared to 12.3% (Investing.com 2018).

NAB debt to equity by 2017 was 2.64 compared to 2.68 industry value. This value shows that NAB has been relying heavily on debt financing than equity financing over the year. On the other hand, Westpac debt to equity in the year 2017 was 3.07 which was slightly higher than the industry value of 2.68 (Investing.com 2018). This shows that Westpac has been relying heavily on debt finance rather than equity finance.

NAB dividend yield by 2017 was 6.98% in comparison to 6.39% industry value. This implies that NAB has been paying its shareholders significantly high amount of dividends which is so encouraging to even the potential investors (Investing.com 2018). On the other hand, Westpac dividend yield in the year 2017 was 6.63% compared to 6.39% industry value. This value shows that Westpac has been operating efficiently and has been more aggressive in paying high amount of dividends far much better than what has been set by the industry.

Based on NAB income statement, it is evident that net interest income for the bank increased from 12,930 in 2016 to 13,182 in 2017 (Investing.com 2018). The total interest income after the loan loss was 12,117 in 2016 but has increased in 2017 to 12,358. Further, net income before the taxes decreased from 8,978 in 2016 to around 8,661 in 2017. Moreover, the net income after the taxes decreased from 6,425 in 2016 to approximate 6,181 in 2017. On the other hand, based on NAB balance sheet, it is evident that total assets for NAB increased over the last two years moving from 776,710 in 2016 to 788,325 in 2017 (Investing.com 2018). On the other hand, total liabilities for the bank increased from 725,418 in 2016 to 737,019 in 2017. Despite the increase in total liabilities, it is evident that the total liabilities for the past two years was relatively lower than its total assets meaning that the company had more assets; hence, did not relying heavily on debt in financing its assets. Further, total equity for NAB increased with a slight margin moving from 51,292 in 2016 to 51,306 in the year 2017 (Investing.com 2018).

Bottom-Up Approach

On the other hand, based on Westpac income statement, it can be stated that is net interest income increased from 15,148 in 2016 to 15,516 in the year 2017 (Investing.com 2018). Net income before taxes also experienced a significant increase over the year from 10,644 in 2016 to about 11,515 in 2017. Similarly, its net income after tax increased from 7,460 in 2016 to around 7,997 in 2017.  Based on Westpac balance sheet, it is evident that the bank total assets increased from 851,875 in 2016 to around 871,855 in 2017 (Investing.com 2018). On the other hand, its total liabilities increased from 790,587 in 2016 to around 809,240 in the year 2017. The total liabilities for the last two years were relatively lower than the total assets meaning that Westpac had enough assets in running its operations. Its total equity increased from 61,288 in 2016 to 62,615 in the year 2017.

Based on the above analysis, it can be stated that Westpac Banking Corporation is doing relatively better than NAB. This is based on the fact that Westpac had significantly higher net income compared to NAB. Furthermore, Westpac had significantly higher profitability ratios compared to its counterpart NAB.

In conclusion, Australian banking Industry is the most profitable and competitive sector. Besides, Australian banking industry is one of the largest portions of the country’s financial systems. Westpac is the Australian financial and banking-service provider whose headquarter is in Sydney. In fact, it is amongst the big four financial institutions operating in Australia. On the other hand, NAB is amongst the big four Australian banks in terms of customers, earnings and market capitalization. It was ranked twenty first largest financial institutions across the world in terms of market cap and forty one largest financial institutions across the globe in term of total assets. Further, based on the top-down analysis, top-down analysis, it can be concluded that Australian economic growth is entering its mature phase. This is based on the fact that the country macroeconomic aspects seem to be moving in favorable position. For instance, Australia is experiencing middling GDP growth rate of around 2.6 % in the year 2016, which is the fastest in over a decade, though it slowed to around 2.2% over the year 2017. Nonetheless, the country GDP is projected to accelerate by end of this year to around 2.9%.  Based on the top-down analysis, it can be concluded that Westpac and NAB have had sound improvement in its financial performance over the last few years. This is due to the fact that Westpac and NAB net profit margin, EPS, ROE and the ROA should strong and improved financial performance due to the high value in these ratios. In spite of the low current assets in the year 2017, it can be concluded that the two banks were able to meet both their medium, long and short-term debt obligations.  

Based on the above analysis, the paper recommends that potential investors and existing one should opt to invest in shares and stocks of NAB and Westpac. In fact, given that Westpac and NAB are performing better financially, it would be noble for any potential investor to invest their cash in these banks since there is a highly probability that they would get higher returns at the end. Basically, based on the fact that Westpac and NAB are paying high dividends to its shareholders, there is need for existing shareholders to invest more on this company by purchasing more shares. By doing so, they are more likely to enjoy high returns in their investments in future.

Reference

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Investing.com (2018), National Australia Bank Ltd (NAB): Viewed from: https://www.investing.com/equities/westpac-banking-corporation-income-statement (Accessed at 18th September 2018)

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