What does WBC do?
Westpac Bank [ASX:WBC] is one of the Big Four banks, with operations across Australia and NZ. Its main business is consumer banking, which centres on home loans. It’s also involved in business banking, institutional banking and funds management via an interest in BT Funds Management.
What’s happening to Westpac’s share price?
Today, Westpac released its half-yearly results. The market didn’t like the numbers; as a result, the share price dropped around 5% at one point, to a low of $29.29.
That’s a very large one-day move for a bank.
What was the problem? On the surface things didn’t look too bad. Cash earnings rose 3%, while revenues increased 5%.
But the main indicator of profitability, return on equity (ROE), fell 166 basis points year-on-year, to 14.2%.
In my experience, ROE is the primary driver of stock prices. When ROE expands (for example, if it moves from 10% to 12%) the share price will rise. When the ROE falls (as it did in Westpac’s case) the share price will fall.
You can analyse all the moving pieces of the banks result, but it all condenses into the ROE. ROE simply measures how efficiently the company is using shareholders’ funds.
One thing that provides an artificial boost to ROE is debt, and Aussie banks are highly leveraged. The bank regulator, APRA, is attempting to address this high leverage by requiring the banks to hold higher levels of capital. Doing so has the effect of reducing ROE — and the share price in turn.
What now for WBC?
This isn’t a new development. The market has been pricing in a lower level of profitability for the banks for some time now. You can see this in the performance of WBC over the past year. The chart below shows the stock peaked a year ago, at $40 per share. It’s now trading just under $30.
The trend remains down, and a break below the recent lows around $28 suggests the fundamental backdrop is getting worse for Westpac.
There was a hint of this in the half-yearly result. For years, the powerhouse for the bank has been the consumer banking division, which is basically the home loan division. In the year to 31 March, 2016, cash earnings grew a very healthy 16%. But most of that growth came in the first half. Second-half growth slowed to just 5%.
Given the slowdown, and the ongoing downtrend in the share price, Westpac is a stock to avoid. A break below $28 will be a bearish development, suggesting the environment for banks is getting worse.
Never assess a stock’s fundamentals without looking at the chart too. Combining fundamental analysis with charting can yield powerful results.
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Editor, The Daily Reckoning