NatWest: What We Think of the Stock After Earnings

Key Morningstar Metrics for NatWest Group

• Fair Value Estimate
  : GBX 750
• Morningstar Rating
  : ★★★
• Morningstar Economic Moat Rating
  : Narrow
• Morningstar Uncertainty Rating
  : Medium

What We Thought of NatWest Group’s Earnings

NatWest reported second-quarter operating profit of £2.3 billion, up 12% sequentially on net interest income outpacing expenses.

Why it matters: Net interest income increased 3% from the first quarter, supported by a 2-basis-point net interest margin expansion and 1% average interest-earning assets growth. Similar to its UK peers, NatWest saw lending margin pressure, particularly in the mortgage market.

• Noninterest income increased 15%, albeit it is a smaller contributor to total income than net interest income. With the acquisition of Evelyn Partners, NatWest has more than doubled its assets under management and administration, beefing up its base from which it can generate fee income.
• Operating expense growth of 1.8% compared with income growth of 3.3% resulted in positive operating leverage effects. Lower impairments of 13 basis points versus 26 basis points in the first quarter also contributed to the good second-quarter results.

The bottom line: We raise our fair value estimate to GBX 750/USD 20.10 per share from GBX 710/USD 18.90 after lifting our net interest margin and capital distribution assumptions. Shares trade in 3-star territory.

• We maintain our Narrow Morningstar Economic Moat Rating. We believe that NatWest’s access to low-cost and stable funding allows it to outearn its cost of equity comfortably in the midcycle. We model for a return on tangible equity of 18% versus a cost of equity of 9.9%.
• Given the current swap rate curve, we expect stronger benefits from the structural hedge, lifting our net interest margin assumption by 10 basis points. We also see greater capacity for capital distributions as a result of our increased margin assumptions.