Westpac’s (ASX: WBC) fiscal 2025 profit fell 2% to $7 billion. Loan growth supported a 3% increase in revenue but proved no match for a 9% increase in operating expenses. In addition to wage growth, the big drag came from restructuring costs and ramping up work on its simplification project—Unite.

Why it matters: Earnings missed our expectations by almost 6%, mostly on temporary operating expenses associated with restructuring (one third of the expense increase) and Unite. Loan growth, net interest margins of 1.94%, and low bad debts, were all broadly as expected.

  • We reduce our earnings forecasts for fiscal 2026 to fiscal 2028 by an average of 7% per year, with cost savings less gradual than previously expected. We understand that the more material savings will be when banking systems are decommissioned late in fiscal 2028.
  • Importantly, we still expect the poor cost/income ratio of 53% to improve to 46% by fiscal 2030. As Westpac reduces headcount, big project spend completes, and technology investments yield benefits. The average of peers is below 50%, with market leader Commonwealth Bank at 46%.

The bottom line: We increase our fair value estimate by 5% to $30.50 for wide-moat Westpac. The time value of money and the benefit from modestly reducing our midcycle required capital more than outweighs lower short-term earnings. We forecast a midcycle ROE of 12%, up from below 10% currently.

  • Shares are materially overvalued. On a forward P/E of 19 times and a fully franked dividend yield below 4%, we don’t see a sufficient margin of safety given modest earnings growth, potential credit stress, or technology simplification risks.

Key stats: Fully franked dividend of $1.53 per share is up 1%, excluding a special dividend paid last year, at the top end of the 65%-75% payout range. Supported by surplus capital, with a common equity Tier 1 ratio of 12.53% well above the 11.25% target, modest dividend growth is maintainable.

Westpac loan and deposit growth picks up, but more efficiency improvement required

Westpac Bank 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. Most nonbanking units have been divested, including general, life, and mortgage insurance.

Westpac’s multibrand strategy owes to acquisitions, such as St. George Bank in 2008, to provide access to a broader customer base and add scale. Only recently has Westpac began colocating branches and building IT systems which allow any customer to be served in any branch. A focus on digital channels to improve the customer experience are required to remain competitive, and have the potential to lower the cost base.

The main current influences on earnings growth are modest credit growth margin management as the cash rate begins to fall. Pressure will be on banks to moderate how aggressively they discount new loans and offers on savings and term deposits. Operating expenses should rise modestly as the bank resets its cost base after completing a number of remediation and technology projects. The bank has suffered from slow approval times in home lending, but increased resources and digital investments have improved service levels.

After enjoying super-low impairment charges pre-2020, we expect a return to midcycle levels around 0.17% in fiscal 2030. There is a risk of higher losses in the short term as households and business face a material increase in interest costs, but our base case is that only a small percentage will default.

Bulls say

  • Despite recent cuts, the cash rate is still much higher than before covid, a better environment for customer deposit funding banks to expand margins and drive higher return on equity.
  • Cost and capital advantages over regional banks and neo-banks provide a platform to win back market share.
  • Consumer banking provides earnings diversity to complement the more volatile returns generated from business and wholesale banking activities.

Bears say

  • Slow core earnings growth resurfaces because of low loan growth, margin compression, subdued wealth and markets income, lower banking fee income.
  • Increasing pressure on stressed global credit markets could increase wholesale funding costs.
  • The bank failing to reset the cost base would leave it at a large disadvantage to peers when it comes to operating efficiency and ROE.

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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.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

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.