Shareholders Lose On CBA Demerger

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies. For more info SHARE ANALYSIS: CBA

Commonwealth Bank intends to de-merge its wealth management businesses and brokers, while mildly positive about the development, emphasise that heightened risks continue.

-Not an IPO and will not provide a release of capital to CBA
-Outlook remains challenging and risks are still seen skewed to the downside
-Wealth management division considered difficult to value

By Eva Brocklehurst

Commonwealth Bank ((CBA)) is rearranging its business, returning the focus to being a bank. Wealth management and mortgage broking will be hived off to form CFS Group.

This will include the Colonial First State platforms and funds management as well as financial planning businesses, third-party distribution including aligned financial advice, minority shareholdings in CountPlus ((CUP)) & Mortgage Choice ((MOC)) and Aussie Home Loans.

The spin off will not affect the bank's distribution partnership with Hong Kong-based AIA Group in relation to life products. General insurance will not be part of this new entity but is subject to a strategic review.

Brokers suspect CBA will ultimately divest the insurance business and Credit Suisse highlights Insurance Australia Group ((IAG)) as a likely candidate for acquisition.

IAG has excess capital and there is a logical growth opportunity in a strategic partnership with Commonwealth Bank.

This is not the previous divestment version that was flagged, an IPO of wealth management, and will not provide a release of capital.

CBA does not intend to retain any shareholding in CFS Group and has highlighted a pro forma 2017 net profit of $500m will continue to provide capacity to pay franked dividends. Shareholders will receive shares in the new entity proportional to existing holdings.

The recent de-rating of the stock presents a rare opportunity, CLSA suggests, as residual risks posed by the AUSTRAC investigation are manageable and the register is skewed to sticky retail investors.

This means domestic and international institutions are structurally underweight a significant component of the benchmark.

The broker considers CBA to be among the highest source of individual benchmark deviation risks in Asia. Not one of the eight stockbrokers monitored on the FNArena database, CLSA retains an Outperform rating and $75.88 target.

UBS considers the grouping into CFS Group is a logical formation and continues to support the bank's strong franchise and market position. The broker expects the majority of the bank's returns to come from dividends.

Nevertheless, the broker concedes the outlook is challenging and risks are skewed to the downside, while regulatory risks remain very high. UBS AG, Australia branch is acting as adviser to CBA on the intention to de-merge the businesses.

The errors in the former strategy are now easy to see, Shaw and Partners asserts.

After 20 years ago deciding the future of banking lay with life insurance and wealth management, Commonwealth Bank has realised that a financial planning network incurs reputation and earnings risk. Life insurance also brings… life insurance risk.

The broker points out that revenue margins in wealth management are falling faster than bank margins.

Hence, the bank will be able to focus on being a bank and the new entity will be able to focus on the issues prevailing in wealth management such as vertical integration, grandfathered commissions and adviser remuneration.

Difficult To Value

Shaw and Partners expects the value of the new entity will be heavily influenced by grandfathering commissions and vertical integration but should be worth at least $5bn. The broker, also not one of the eight, maintains a Buy rating and $78 target on CBA.

Deutsche Bank suspects there is limited impact on the bank's returns in the short term based on its preliminary analysis. The proposed de-merger are also means cash capital returns to shareholders are less likely and this transaction is unlikely to be a catalyst for the stock.

Macquarie calculates the value of the wealth management segment could range between $6.5-10bn. As the bank has chosen to de-merge it will have to absorb the separation costs within its capital base.

CBA could incur potential remediation provisions and, given the likely investment needed to support the businesses in the medium term, additional injections of capital could be warranted.

While the current capital position is healthy, the broker envisages less scope for near-term capital management after this announcement.

Macquarie estimates the wealth management business contributes around 25% return on equity (ROE) and expects, therefore, CBA's ROE will decline by around -40 basis points when the division is divested.

As a result, sustainable pay-out ratios and dividends could decline by -2% and -7%, respectively, although the broker recognises shareholders would be entitled to a dividend from a newly created entity.

All up, Macquarie believes the premium in CBA stock is difficult to justify and maintains a Neutral rating.

Executive Appointments

The bank has announced six executive appointments, including its deputy CEO, chief risk officer and head of retail banking services but is yet to fill the chief financial officer role.

There are two Sell ratings, five Hold and one Buy (Morgans, yet to comment on the de-merger) on the database. The consensus target is $73.63, suggesting 1.2% upside to the last share price.

Targets range from $64 (Morgan Stanley, yet to comment on the de-merger) to $79 (Morgans). The dividend yield on FY18 and FY19 forecasts is 5.9% and 6.0% respectively.

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