Analyzing Westpac's Performance Over Five Years

Overview of Westpac

Question:

Discuss about the Analysis for Westpac.

Headquartered in Westpac Place, Sydney Westpac is an Australian bank which is also engaged in the provision of financial services. Founded in the year 1982 the organization has come a long way to become one of the four largest banks in Australia. The organization commands a base of more than 13 million customers and operates with over 1429 branches and 3850 ATMs across the globe and is the second largest bank in New Zealand. The primary objective of this report is to analyze the performance of the organization over a period of five years while analyzing the performance of the share of the concern.

The overall picture of the Australian banking system is not pretty. The banks in Australia and few of the other parts of the world are struggling considering the downturn in the economy. Specifically in Australia where the banks had primarily lend or forwarded loans to the steel and coal industry are struggling as these industries have not done well for quite some time now. Recently the earnings were missed by Westpac, one of the largest banks in the world as of 1st of May 2016. The profits reported for the 6 months ending March were approximately $0.125 lower than the expected amount (StreetAuthority, 2016). The bank in addition to the same reported its biggest impairment loss in the previous six years. As a consequence of the same the price of the share of the organization went down from $23.59 to $22.71 on Monday. This does not look very good for the organization and the overall industry as the results of the other banks were yet to be reported. It is understood that the others are in the same boat as Westpac and that more bad news awaits the investors and the shareholders. In addition to the same four of the largest banks of the continent posted bad debt charges in excess of $3.8 billion. However, in spite these figures the banks in Australia are performing much better than the banks in USA, England, France and other parts of the world and the situation in expected to even out in the next few years (Keating et al., 2008). The fall in the profits of the coal and steel organizations is primarily due to the fall in the demand levels of China which is the world’s largest consumer of these materials. However the biggest plus or the motivating factor is that the Australian economy has not been impacted by recession for the last 24 years and the same will provide a steady environment for the banks to operate.

In the last one year the share of the organization has not performed well. The same has gone down by approximately 7%. It is not just Westpac which has felt the heat but the share prices of other banks such as Commonwealth Bank of Australia and Australian and New Zealand Banking Group have also gone down by approximately 8% and 11% respectively (Mickleboro, 2016). Westpac has been paying healthy dividends over the years and in the last year the organization paid dividends yielding around 6% fully franked. In addition to the same the organization also has a payout ratio of approximately 73% which is quite healthy. This is supposed to create a buying pressure in the market and stop the fall of the shares further. Hence from the investor point of view the same should provide a good opportunity and should be a good buy. Even though the cash earnings of the organization have increased with an increase in the revenue the return on equity has not particularly been that good which one of the primary reasons is for the fall in the share price of the organization (Canavan, 2016). As is evident from the ratios in the appendices the organization’s ROE has fallen from 15.91% in the year 2014 to 15.77 in the year 2015. As compared to the year 2011 the performance of the organization has dipped. In the year its return on equity was 17.47 while in 2015 it is 15.77 which is almost a fall of roughly 2%. This has adversely impacted the price of the share of the organization.  The table below indicates the price of the share of the organization over a period of 2 years. Since February 2015 the price of the share of the organization has fallen by over $10 which is quite astounding (Davidson and Salsbury, 2005).

The Australian Banking System

The graph above indicates the fact that price of the share of the organization has moved upwards and downwards. Since 2015 the price of the organization’s share has shown a drastic fall as has been mentioned previously.

An analysis of the income statement of the organization over a period of 5 years indicates the fact that the Interest income of the organization has reduced over a period of five years. The same has reduced from $38098 million to $32307 million. Even though the income of the organization has fallen the organization has also been able to bring about a reduction in the interest expenses (Berk and DeMarzo, 2007). The interest expense of the organization has reduced from $26102 million in the year 2011 to $18028 in the year 2015. The same is evident from the table below which indicates the reduction in the expenses and income but an overall increase in the net revenue as compared to the year 2011.

The basic earnings of the organization have also increased from $2.31 in the year 2011 to $2.55 in the year 2015. The same is the case with the diluted earnings of the organization which has increased from $2.22 in the year 2011 to $2.48 in the year 2015. Even though the income of the organization has increased in absolute terms the same is lower in terms of percentage and has fallen as compared to the previous year (Broadbent and Cullen, 2003).

The recent scandal discovered could be a big blow to the organization. It was found that millions of dollars in loans were approved on basis of Chinese documents which were fraud. These documents were prepared by phony mortgage brokers. Considering the same the bank’s policy and levels of internal control are a big question as a proper internal control should have prevented the same. In addition to the same a few other incidents have surfaced indicating wrong overdraft credit limits being sanctioned to people (La Berge, n.d.). This definitely indicates the concern over the use of technology and system in place. According to the AFR’s report approximately $1 Billion of the loans of the bank might have affected by the scandal and might have to write them off as bad which will drastically reduce the profits if the bank was to restate the income statement (Fund, 2012).

The bank has recently been accused of fixing the swap rate illegally. It has been alleged that the bank was involved in fixing the swap rates between April 6 2010 and June 6 2012. In a statement the ASIC claimed that “Westpac intended to create an artificial price for the bank bills”. It also claimed that “Westpac had a large number of products which were priced or valued off BBSW and that it traded in the bank bill market with the intention of moving the BBSW higher or lower”. If the same goes against the bank it can prove to be very costly and humiliating. The bank might be fined billions of dollars and might even be barred from trading on Australian Stock Exchange for a while (Shanahan, 2016).

Analysis of Westpac's Share Performance

This segment of the report analyzes the performance of the bank with the help of the tool of ratio analysis. The tool of ratio analysis enables the users of the financial statements to analyze the performance of the organization in a short while without having to refer to the entire set of annual reports of the organization. As a consequence the tool of ratio analysis is easy to employ and can be understood with easy as the user of the same does not need to a master in accounts or finance. The various ratios of the organization have been explained below:

Net profit: The net profit ratio of the organization is used to analyze the overall performance of the concern. This is an overall measure as the same takes into consideration the overall incomes and expenses of the concern unlike the gross profit ratio and the operating margin ratios which do not consider all the incomes and expenses of the organization and hence do not present the picture of the overall performance of the concern (Financial performance, 2011). The net profit ratio or net profit margin of Westpac has reduced over a period of 5 years starting from 2011. The ratio has reduced from 41.34% in the year 2011 to 36.99% in the year 2015. The net profit percentage decrease can be primarily because of the fact that the rise in the expenses of the organization was more than the rise in the revenue of the concern (Fridson and Alvarez, 2002). This has primarily been the case with the organization whose revenue has not shown or indicated a great deal of improvement. Considering the same the organization should consider reducing the operational and other costs associated with the organization as the same is bringing down the performance of the organization. The operating margin of the organization has also declined from 57.1% in the year 2014 to 52.7% in the year 2015 though over a period of five years the operating margin of the concern has improved from 50.3% in the year 2011 to 52.7% (Lee, 2005).

Return on asset: This ratio indicates the return earned by the organization by employing the overall assets or the average assets of the corporation. The higher the ratio the better it is for the organization as the same indicates the increased efficiency of the concern (Mattern, 2002). The return on assets for Westpac has depleted over the years as the same has come down from 1.09% in the year 2011 to 1.01% in the year 2015. As a consequence of the same the share price of the organization has also taken a hit and the same has gone down by approximately by $10 over a period of 2 years (McKeown, 2012).

Debt to Equity: The debt to equity ratio as the name suggest indicates the proportion of the organization’s debt to its equity (Pratt and Grabowski, 2008). Though a higher debt implies that the organization has a higher leveraged earning the same can be bad during the times of recessionary pressure. However considering the fact that the Australian economy has not been hit by recession for a period of 24 years the same can be considered to be safe (Westpac, 2016). The debt to equity ratio of the organization has increased over a period of 10 years but the same has reduced over a period of 5 years wherein the same has come down from 3.96 in 2011 to 3.48 in the year 2015 (Shim and Siegel, 2000).

Westpac's Dividend Payments and Payout Ratio

P/E Ratio: This ratio indicates the price of the share in regards to the earnings made. The price earnings ratio of the organization has fallen over a period of 5 years. Specifically over the last three years the same has come down from $12.64 to $11.80 as of 2015 (Temte, 2004). This indicates a fall in both the price and earnings per share of the organization over this period.

Even though the same is easy to use the same does not take into consideration the impact of qualitative information and other basic concepts of finance such as inflation and time value of money (Worthington, 2006).  Hence an informed decision can only be taken in the light of the quantitative and qualitative information in the light of the current environment surrounding the organization.

According the constant dividend growth rate model the price of the share is as follows:

P= D/K-G

Where,

P= Price of the share

D=Dividend paid by the organization

K= Return expected by the equity holders

G= Rate of growth

Applying the above formula the theoretical share price of the organization is as follows:

=1.76/9%-4%

=1.76/5%

=$35.2

The current market price of the share is $28.8 as of 1^st of June 2016 which is lower than the theoretical price of the share. Considering the same the share should be bought by the investors.

It is evident from the analysis above that over the last five years the organization has not performed really well and the profitability and other key aspects of the financial performance and financial position have taken a hit. The net profit of the organization has reduced in addition to the increase in the debt level of the concern. The share price of the concern has also taken a hit in the light of the reduced earnings and return on assets of the organization. However considering the fact that the Australian banking sector has been performing well when compared with the banking sectors in the other parts of the world the same is expected to improve over the course of time. As has been previously mentioned the Australian economy has not been impacted by recession for quite some time now indicates the sound financial and economic environment which should provide a steady base to the banks in the nation. In light of the same the investors should purchase the share of the organization. 

References

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Davidson, L & Salsbury, S 2005, Australia's first bank, Sydney, NSW: UNSW Press.

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Pratt, S. and Grabowski, R. 2008. Cost of capital. Hob Add Free Sample oken, N.J.: John Wiley & Sons.

Shanahan, L 2016, Westpac accused of fixing market. Viewed on 29 June 2016, https://www.theaustralian.com.au/business/financial-services/westpac-accused-by-asic-of-fixing-bank-bill-swap-rate/news-story/3b832d0e86f76c8b97821bc8db0328bc.

Shim, J & Siegel, J 2000, Financial management,   Hauppauge, N.Y.: Barron's.

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Westpac, 2016, Annual reports 2014, viewed on 29 June 2016, https://www.westpac.com.au/about-westpac/investor-centre/financial-information/annual-reports/.

Worthington, S 2006, Equity, Oxford: Oxford University Press.