The Westpac Banking Corp (ASX: WBC) share price is outperforming the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index and its peers after a leading broker upgraded the stock while flagging the possibility of a capital raise.
Any talk of raising capital usually will depress a stock, but not in Westpac's case.
The WBC share price jumped 1.1% to $28.54 during lunch time trade when the Commonwealth Bank of Australia (ASX: CBA) share price inched up 0.2% to $79.07, the Australia and New Zealand Banking Group (ASX: ANZ) share price gained 0.4% to $26.80 and the National Australia Bank Ltd. (ASX: NAB) share price added 0.2% to $27.38.
While the Westpac share price isn't the worst performer of the big banks over the past year (that would be ANZ and you can click here to find out why), Credit Suisse says it is trading at 10-year lows in terms of relative sector valuation.
Capital raise to trigger stock re-rating
But that is about to change. The broker believes that some of the key headwinds that has been holding the stock back will reverse soon and it upgraded its recommendation on the stock to "outperform" from "neutral".
Credit Suisse pointed out the three things depressing the stock are its weaker capital position that could prevent it from hitting APRA's "unquestionably strong" CET1 ratio of 10.5%, worries that it will have to cut its dividend given its headline payout ratio of 98% (or 80% on an underlying basis) and its stubbornly high costs as it invests in its customer service hub initiative.
"We think capital and dividend could be dealt with at the upcoming result with a capital raising of the order $1.5-2bn adding 35-50 bp of CET1 and a 10-15cps cut in the semi-annual dividend," said Credit Suisse.
"While asset sales are possible, timing of completion means more urgent action on capital is required."
Westpac likely to cut dividend
The fact that Westpac is outperforming today means investors would probably welcome the chance to buy new shares (which will likely be priced at a discount) under a raising.
The bank could also address worries about its cost base by accelerating the implementation of the customer service hub too. While that will require additional investment, the bank could cover that off by slightly increasing the size of the potential cap raise by around $500 million.
Credit Suisse thinks the market will be more than happy to accommodate the extra cash injection if it meant that costs will fall sooner rather than later and at a time when the bank's net interest margin is under pressure.
But investors should be prepared for a dividend cut when Westpac releases its full year results in November.
"We have incorporated $2bn of additional capital together with a 10cps per half dividend cut to 84cps," said Credit Suisse.
"With our expectation of at least two of the key overhangs likely to be removed, and given sector relative valuation, we upgrade WBC to OUTPERFORM with a A$30.55 target price (from A$28.60)."
