Westpac (ASX: WBC) is the second-largest of Australia’s four major banks. The bank provides a range of banking and financial services to retail and business customers, including mortgages, consumer finance, credit cards, business loans, and term deposits. Following the divestment of its financial planning and advice business, even its wealth arm--BT Financial Group--is likely to go. Under new leadership, most nonbanking units are being divested, including general, life, and mortgage insurance.

Shares in wide-moat Westpac remain undervalued, trading at a material discount to our unchanged AUD 28 fair value estimate. Investors remain unconvinced the bank can grow revenue in line with peers and simultaneously achieve operating cost savings.
We are more optimistic. We expect Westpac to increase home loans in line with the market, at around 3.5% per year. Regulatory clouds, which made Westpac overly restrictive, are passing. Investments to automate processes, plus additional headcount, are helping Westpac approve loans much quicker now.

We also expect temporary headwinds to abate. Westpac was overweight in investor lending, which has been weak, and had offshore processing affected by COVID-19. With approval times improving and funding cost advantage over small banks and nonbank lenders, we expect Westpac to hold share in the future.

On our forecasts, Westpac improves its cost/income ratio relative to peers, but does not get down to pre-2019 levels. Our fiscal 2027 cost/income ratio forecast is around 46%, well above the 42.5% average we forecast for the other major banks. We still see value even if it remains one of the least cost-efficient of the major banks, as we expect.

Westpac trades on fiscal 2024 P/E of 11 times, compared with an average of 13 times for peers. We think this discount should close as Westpac delivers better earnings growth. Our EPS CAGR for Westpac of 9% between fiscal 2022 and 2027 compares with around 5% for major bank peers. Based on a 70% payout ratio, Westpac's dividend yield over 6% is attractive. If earnings prove weaker than our forecasts, the bank can also use its surplus capital to prop up dividends.

For an in-depth analysis of our positive thesis, Morningstar Investor subscribers can refer to our July 2023 Westpac Stock Pitch “Operational Issues and Costs Are Improving, and Shares Are Cheap.”