Positive momentum was the focus of Bendigo’s (ASX: BEN) investor update, with management pointing to a refreshed banking app and a new lending platform as foundations to help the bank increase loans in line with the market. The balance sheet acquisition of RACQ Bank is expected to be ROE-accretive.

Why it matters: RACQ adds 4% to our fiscal 2027 loan and deposit forecasts, and around 5% to profit from fiscal 2028. We like the strategic merit, more low-cost deposits, a low-credit-risk home loan book, leveraging the existing Bendigo cost base, and not paying a premium to book value.

  • We increase our profit forecasts from fiscal 2028 by a more modest 1% though, after reassessing our expense growth forecasts for the group. Management reiterated a target to keep annual expense growth from rising above inflation, making flat costs in fiscal 2027 and 2028 unlikely.
  • We expect cost savings from lower headcount and system consolidation to help bring the cost/income ratio down to 58% in fiscal 2030, from 62% in fiscal 2025, which is less ambitious than the 57% we previously forecast.

The bottom line: Our fair value estimate for no-moat-rated Bendigo and Adelaide Bank is unchanged at $11 per share. This includes the acquisition of RACQ, which still needs regulatory approval.

  • Shares are modestly undervalued on a forward P/E of 11 and a fully franked dividend yield of 6%. Our forecasts imply average profit growth of 3.5% over the next five years.

Coming up: Management provided no new information on the anti-money laundering issues raised last week, and the uncertainty is weighing on the share price.

  • We have estimated an ongoing $20 million uplift for risk-related expenses. We have not assumed a penalty or additional capital overlay, but both are possible depending on the regulators’ assessment of shortcomings and Bendigo’s prioritization of risk and compliance.

Bendigo’s efficiency initiatives should drive cost / income improvement

Bendigo and Adelaide Bank is one of Australia’s top 10 largest banks, but by loans and deposits is much smaller than the four major banks. A higher cost/income ratio and funding costs make it difficult to generate attractive returns on shareholder capital in a competitive market. The acquisitions of Adelaide Bank, Rural Bank, and Delphi Bank have helped scale and diversify the loan book, but revenue gains and synergy benefits to date have failed to generate excess returns on equity given the larger capital base.

The main earnings growth influences are modest credit growth, low loan impairment expenses given large provision balances and serviceability assessment, pressure on funding costs, and intense lending competition—all of which constrain interest margins. Operating expenses are increasing as the bank invests in technology, adds capacity to handle more loan volumes, and raises regulatory and compliance spending.

Bendigo is focused on growing the loan book while increasing operating efficiencies via investment in digital processes, consolidation of banking platforms, technology applications, and products. Growth in customer numbers (particularly younger customers) are early vindication of the strategy, but we do not believe it will translate into equally impressive profit growth.

Bendigo took full ownership of mobile-only bank digital bank Up in 2021. The bank has seen strong growth in the 16 to 25-year-old age group. While young customers tend to have less savings and smaller loans, building a relationship with this demographic could provide future opportunities. A dual strategy makes sense, but Bendigo’s long-standing strength as a community- and relationship-based bank is unlikely to be replicated in digital channels where offerings lack differentiation, and major banks are spending big.

We expect agriculture to remain a niche focus in business lending. In addition to having branches located within agriculturally reliant communities, sector specialists who can appropriately price risk and provide quick response times for loan applications should help the bank hold its market share.

Bulls say

  • Investments in mobile banking and the approval process help Bendigo grow customer numbers, taking share of customer deposits and home loans.
  • Customer deposit switching to term deposits slows with Bendigo retaining a large percentage of funding from low-cost transaction accounts and saving balances.
  • Bendigo moving to advanced accreditation (using internal models to assess credit and market risk) has the potential to free up capital which can be used to grow assets or make additional returns to shareholders.

Bears say

  • Bendigo struggles to compete with the four major banks because of their size, cost advantages, market presence, and distribution capabilities.
  • Customers placing less emphasis on local branches could make it more difficult for Bendigo to raise deposits cheaply via its community bank branches, putting pressure on funding costs. Its digital bank could help offset the headwind, but competition is intense.
  • Cost savings from efficiency gains could be offset by investment in technology to meet customer expectations and rising regulatory requirements.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.