Is National Australia Bank Ltd a bargain?

Our number one business bank trades on the lowest earnings multiples. But does it deserve to?

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National Australia Bank Ltd (ASX: NAB) is Australia’s fourth largest financial institution. However despite being much smaller than some of its peers, NAB is our premier business bank.

According to APRA it controls 24.6% and 31% of Australia’s business banking and agribusiness, respectively, whilst in New Zealand its share of each stands at 26.6% and 21.7%. Although smaller than rival Australia and New Zealand Banking Group (ASX: ANZ), it holds exactly the same market share of Australian mortgages, currently 15.2%.

As a result, NAB’s Australian Banking unit remains the highest grossing business unit, and in the bank’s most recent half-year notched up cash earnings of $2.474 billion. However it should be noted NAB’s push for greater market share has cost it significantly in terms of efficiency and margins.

Its Australian Banking division has a Net Interest Margin (a key measure of bank profitability, which is essentially the profit it peels off between deposits and loans) of just 1.63%. ANZ’s Australian operations achieved a margin of 2.48% for the most recent half year – which is a big difference when you’re dealing with billions of dollars!

Over in the United Kingdom NAB has two divisions. Its Commercial Real Estate division continues to plague management and shareholders, but is essentially tasked only with drawing down underperforming assets. In its most recent half-yearly results it (again) produced a loss. However, thanks to a slowly improving economy, the UK Banking division showed improved earnings growth with a Net Interest Margin of 2.25%. However, its cost to income ratio was a whopping 70.3%!

Despite smaller profit margins and a lesser return on equity (currently 14.6%) than its peers, NAB has built up a strong APRA Basel III common equity tier 1 ratio of 8.64%. This compares with Commonwealth Bank of Australia’s (ASX: CBA) 8.5%. At current prices, NAB is forecast to pay a 5.9% fully franked dividend, ahead of its three peers who are forecast to average just 5.1%.

To buy or not to buy

When interest rates rise, we could see NAB’s focus on increasing market share pay off. However despite being the cheapest big bank across a number of valuation metrics, it deserves to be, given its much lower profitability and ongoing troubles in the UK. If I was looking for an income play to my portfolio I would pay no more than $24 per share. In addition, I would hope management can continue to pay down the remaining £3.3 billion in UK commercial loans over the next two years.

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Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any of the mentioned companies. 

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