Australia | Aug 08 2019
A limited negative reaction to a weak FY19 result for Commonwealth Bank bodes well for the FY20 outlook, brokers suggest, although the stock is considered over-priced.
-CommBank's premium to peers considered unjustified
-Effects of lower cash rate likely to be offset by further mortgage re-pricing
-Capital returns expected in FY20 and more RBA rate cuts likely
By Eva Brocklehurst
Softer revenue and a jump in costs produced a weak FY19 result for Commonwealth Bank ((CBA)) yet the share price reaction was fairly muted and, brokers suspect, probably surprised many investors. Citi attributes the limited reaction to the prospect that FY20 will be better, as lending momentum has returned and compliance costs, while continuing, are unlikely to keep growing.
Morgans also considers the result bodes well for the outlook for major bank earnings, in terms of home lending growth and residential mortgage asset quality. Commonwealth Bank expects an improvement in the housing market, noting there is stimulus on the way from tax cuts and infrastructure expenditure which is yet to flow through.
Cash earnings from continuing operations of $8.49bn were slightly below broker estimates. There was a pick up in mortgage lending in the second half, which grew above system for the first time in a number of months. Business lending growth was 4%. Macquarie points out, on the positive side, new business in the home loan portfolio from brokers was 48% in the second half compared with 41% in the prior corresponding half.
Citi expects, while net interest margins have been flat for the last six months, the effect of a lower cash rate should be offset with the benefit of further mortgage re-pricing. Still, the broker acknowledges Commonwealth Bank has modest prospects given more challenging economic conditions ahead.
While investors may take some comfort in management's guidance regarding the impact of recent official rate cuts, Morgan Stanley envisages downside risk to margins and constraints on home loan and deposit re-pricing. Macquarie is also concerned about industry trends of re-pricing mortgages, assessing this is not a sustainable practice.
Costs were the main disappointment and underlying cost inflation of 2.4% was higher than expected. The bank has reiterated an intention to target a longer-term absolute reduction in costs and a sub-40% cost-to-income ratio.
Yet Morgan Stanley is sceptical that the bank can lower the absolute cost base, or achieve the sub-40% ratio over the next three years. Indeed, Macquarie calculates it will take around four years for Commonwealth Bank to achieve cost-to-income targets.
The bank has retained its premium to peers, which many brokers believe is unjustified. Citi calculates Commonwealth Bank trades in excess of 15x FY20 estimates, which is too high for a low single-digit earnings growth profile and a low double-digit return on equity. The broker assesses there are better opportunities elsewhere in the sector and there is a risk that the sizeable premium to peers closes over the next 12 months
Morgan Stanley agrees the valuation is stretched, suspecting underlying earnings will decline and return on equity remain below 13% in FY20. Fee and margin pressures, stemming from lower interest rates, will result in declining revenue trends in both FY20 and FY21. In the face of this, Macquarie also judges the current valuation premium to peers of 26% to be excessive.