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ComBank Outlook Warrants Caution

Australia | Aug 09 2018

This story features COMMONWEALTH BANK OF AUSTRALIA. For more info SHARE ANALYSIS: CBA

The outlook for Commonwealth Bank warrants caution, brokers suggest, despite a strong core retail banking franchise.

-Second half noticeably weaker than the first
-Loan volumes expected to soften and margin headwinds increase
-Cost burden to remain elevated

 

By Eva Brocklehurst

While CET1 capital is emerging as a key strength and FY18 cash earnings growth surprised on the positive side, Commonwealth Bank ((CBA)) has sustained market share losses in all major segments and costs remain elevated.

The FY18 result was not necessarily as bad as some had expected as one-off impacts were well anticipated, Citi suggests. Underlying operating cash earnings growth of 3.7% was a positive and the the stock rallied accordingly.

Yet the second half was noticeably weaker than the first and underlying revenue growth is expected to slow in FY19, as loan volumes soften and margin headwinds increase. Underlying costs growth is expected to remain elevated.

The main points of weakness in FY18 were growth in underlying operating expenses, albeit largely driven by one-off AUSTRAC fines and regulatory costs relating to the Royal Commission, APRA reviews and AUSTRAC legal costs.

Citi notes institutional banking and markets were particularly soft, with cash earnings -14% lower and the majority of the decline occurring in the second half. The performance of this division is expected to remain weak, amid a shrinking lending book and higher wholesale funding spreads.

There is also pressure on the horizon in retail banking, through a larger impact from elevated BBSW rates as well as slowing mortgage volumes. UBS suspects this reflects Australian consumers and business becoming more cautious in a low-income growth environment, exacerbated by the Royal Commission.

CLSA reiterates an Outperform rating, with a $78.28 target, noting core profitability is still strong and the dividend can grow modestly. The broker, not one of the eight monitored daily on the FNArena database, calculates the bank's return on equity of 14.6% in FY19 is well above peers and justifies a premium.

Bell Potter, also not one of the eight, upgrades to Buy from Hold, expecting further share price re-rating, as CBA continues down the transformation path and focuses on high returns in the retail and business banking segments. The target is raised to $80.

Yet, the case for a new round of home loan re-pricing is reduced, Morgan Stanley suspects, thanks to ongoing costs and institutional bank de-leveraging. The resilience of the margin did not make the broker more confident in the outlook, forecasting a margin decline of -5 basis points, amid revenue growth of just 1% in FY19, on the back of moderating volumes and a squeeze from mortgage competition, elevated BBSW rates and loan switching.

Macquarie is Neutral on the bank believing, in the medium term, there is scope to reduce expenses and maintain underlying earnings growth although acknowledges the need to invest is pressing. Moreover, given an overweight position in retail banking, near-term revenue trends are likely to remain weak and these trends do not justify the current premium in the stock.

Deutsche Bank was rather underwhelmed, as the second half was below forecasts at the net profit line, even after adjusting for the AUSTRAC and one-off regulatory costs provisions. Still, given the recent underperformance of the share price, the broker suspects the market may have been anticipating an even worse outcome.

Ord Minnett agrees the reaction may have been a "relief" rally, and some will have taken heart that the bank managed to stem the decline in its net interest margin to just -2.0 basis points half on half. The broker suggests the heavy lifting has already been done on restructuring and divestment in the lead up to the results, following a declaration from the new CEO, Matt Comyn, that he plans to make CBA a "simpler and better bank".

Cost Burden

Morgan Stanley expects weaker revenue growth and that the reinvestment burden – risk and compliance costs – to weigh on expectations in FY19. Growing regulatory and community scrutiny is expected to lead to step-up in expenses over the next two years.

As a minimum, Credit Suisse suggests the cost burden is likely to put CBA at a disadvantage to its peers and there is additional risk of above-peer margin decline while the bank attempts to move back to system growth. CBA remains the least preferred of the major banks for the broker.

The proposed de-merger of CFS Group may signal a review of the dividend policy, Morgan Stanley suggests. Earnings from CFS Group increased around 5% and, using updated estimates and peer multiples, the broker calculates a valuation between $5.7bn and $8.8bn.

Macquarie believes the planned de-merger of CFS is likely to be neutral for capital and the remaining CBA business will experience net profit dropping by -5-6%, although the share count will remain the same.

In terms of strategy, CBA has emphasised being the digital leader in the Australian banking market and has talked for the first time about cost reductions as a medium-term target. Morgans expects the de-merging of the wealth management and mortgage broking businesses will mean a greater focus on improving returns from the core and CBA is the best placed of the major banks to launch a stand-alone, full-service digital bank in Australia.

Capital Strength

Morgans considers the $0.01 increase in the final dividend sends a strong message that underlying earnings are robust and the nominal dividend is not likely to be cut. CBA also appears to be placed to meet APRA's "unquestionably strong" CET1 benchmark of 10.5%, reporting a CET1 capital ratio of 10.1% as of June 2018.

Morgans maintains a positive view on the major banks as dividend yields are robust and cost reductions will soon become a key theme. The broker also expects the regulatory risk premium the sector to ease over the next 12 months.

FNArena's database shows one Buy rating (Morgans), five Hold and two Sell. The consensus target is $73.94, suggesting -0.9% downside to the last share price. The dividend yield on FY19 and FY20 forecasts is 5.8% and 5.9% respectively.

See also, Shareholders Lose On CBA Demerger on June 26, 2018.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

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