Are Westpac shares undervalued by the market?

This leading broker has given its verdict on the banking giant.

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Westpac Banking Corp (ASX: WBC) shares have been on form so far in 2024.

Since the start of the year, the banking giant's shares have rallied 15% and now trade at $26.39.

This means that a $20,000 investment on the final trading day of 2023 would now be worth approximately $23,000 today.

The good news for shareholders is that one leading broker believes that the shares of Australia's oldest bank could still be undervalued.

This could mean that there's still room for them to climb from where they trade today.

Broker says Westpac shares are undervalued

According to a recent note out of Ord Minnett, its analysts think the market is being too negative on Westpac.

The broker believes that rational competition in home loans and customer deposits is on the way and that Westpac stands to benefit more than most.

In light of this, its analysts feel that investors should be focusing less on the near term and more on the medium when it comes to Westpac and its shares. They explain:

As margins shrink and bad debts creep higher, earnings growth will be challenging for the Australian banks in the short term, but the current share price paints too bleak a picture on the medium-term earnings power of Westpac, in our view. Over the next five years, we assume rational competition returns for pricing loans and customer deposits.

This should be good news for Westpac. The broker explains:

As the second-largest lender and deposit holder, Westpac should be a willing participant as it stands to benefit materially. Most Australian banks, excluding Commonwealth Bank, face single digit return on equity in FY24, compared with our assumed 9% cost of equity, supporting our view that current loan and deposit price competition is unlikely to persist indefinitely.

As a result, Ord Minnett feels that the bank's shares are undervalued at current levels. It adds:

Shares in Westpac are undervalued compared with our unchanged $28 fair value estimate.

Double-digits returns to come

With that in mind, based on its current share price of $26.39, Ord Minnett's valuation represents potential upside of 6.1% before dividends.

As for dividends, the broker is forecasting fully franked dividends of $1.45 per share in FY 2024 and then $1.50 per share in FY 2025. This equates to dividend yields of 5.5% and 5.7%, respectively, for investors over the next couple of years.

In total, this means that the broker sees scope for a total return of approximately 11.6% for investors between now and this time next year.

Motley Fool contributor James Mickleboro has positions in Westpac Banking Corporation. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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