Life as an investor in National Australia Bank Ltd. (ASX: NAB) has been tough in the last six months, with the company's shares falling by over 20% during the period. Of course, this is at least partly due to the wider market crash which has taken place, with the ASX being down 12% during the same time period.
However, NAB's future is rather uncertain. It is having to cope with higher regulatory capital requirements which, realistically, could pull capital away from both reinvestment and from increasing dividends over the medium term. And, with the Aussie economy apparently on the brink of a recession due to the collapse in commodity prices, as well as a potential housing bubble which could burst, it is little wonder that the market is somewhat downbeat on NAB's future prospects.
Despite this, NAB could be worth buying right now. The first key reason for this is its income appeal, with NAB currently yielding a fully franked 6.6%. That's 190 basis points higher than the ASX's yield and, with it increasing dividends at an annualised rate of 2% during the last decade, NAB appears to be a reliable income play. Furthermore, with interest rates likely to move lower as the Aussie economy comes under further pressure, NAB's share price may be supported by increased demand from income-seeking investors.
The second reason for NAB's long term potential is its strategy, with the bank set to offload troublesome foreign assets. Chief among them is Clydesdale, which is based in the UK and has been a drain on NAB's performance in recent years. Although the UK economy is now growing, NAB's decision to demerge the bank appears to be a sound move since it should provide it not only with a significant war chest to generate additional growth in future years, but also improve its risk/return profile.
In addition, it should allow NAB to focus its attention on other parts of the business and drive through efficiencies which, given the outlook for the economy, may be necessary in order to prevent upward pressure on NAB's cost:income ratio. For example, NAB Connect has been upgraded with the aim of improving the customer experience, while in business banking NAB has centralised metro and regional fulfilment centres to support improved customer relationships. Both of these changes have the potential to improve customer retention and boost income in the long run.
While the ASX still trades on a price to earnings (P/E) ratio of 14.8 despite its scaled back growth prospects, NAB has a P/E ratio of 12.4. Given that NAB's earnings growth rate over the next two years is forecast to be in excess of that of the wider index at 11.4% per annum, such a rating appears to be rather low.
In fact, it equates to a price to earnings growth (PEG) ratio of 1.08 versus 1.4 for the ASX. For this third reason, NAB's share price may surprise on the upside and, alongside a sound strategy and strong income appeal, it may be a top performer over the medium to long term.
