Commonwealth Bank Fails To Impress

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

Meagre earnings growth and a soft outlook belied a $6bn buyback and restored pay-out, and few were impressed with Commonwealth Bank's FY21 results

-More headwinds to base business from lower rates compared with peers
-Further interest margin drag on the mortgage front book expected in FY22
-Investment expenditure targeting business banking
 

By Eva Brocklehurst

There was something for everyone in the FY21 results from Commonwealth Bank ((CBA)), yet for most brokers this is an expensive stock that is does not justify its trading multiples.

Despite some promising trends, Macquarie was disappointed with meagre earnings growth and believes the competitive environment is intensifying, while the bank's base has greater headwinds from lower official rates compared with its peers.

Pre-provision profits are expected to grow 1-2% per year for the next two years yet this is likely to be behind peers, and this sort of growth rate does not justify the current PE multiple, in the broker's view. While the balance sheet trends remain supportive revenue momentum is weak.

Bell Potter is the exception. Cash net profit of $8.65bn was up 20% and the broker found more positives than negatives, highlighting net interest income, asset quality, capital and liquidity while upgrading the rating to Buy from Hold with a $118 target.

Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, also suggests the pandemic has been good for CBA, which should be able to withstand any further pandemic-related issues, emerging fundamentally stronger when interest rates begin to rise again.

Importantly, the broker includes the value impact of higher excess CET1 capital and notes the level 2 CET1 ratio has increased to 13.1% since the end of the first half, boosted by strong organic capital generation. This is ahead of APRA's "unquestionably strong" requirement of 10.5% and a further boost from divestments should be forthcoming to reach a sector leading 13.49-13.59%.

Morgan Stanley is in the other camp, believing CBA may be a first-class business but expectations are high and the financial metrics do not justify a FY22 PE multiple of more than 20x.

The broker conservatively assumes a CET1 ratio is maintained above 11% and forecasts another $2.5bn buyback in FY23, calculating that total buybacks of $8.5bn would reduce the share count by around -5% over the next two years.

CBA has reiterated its full-year pay-out ratio target of 70-80% and intends to maintain a significant balance of surplus franking credits, also announcing a $6bn buyback with the results.

Citi highlights a restored dividend pay-out ratio and write-backs of provisions, which has been enabled by low rates and excess liquidity, yet asserts excess liquidity will also have an adverse effect on the bank's ability to generate revenue.

Results

FY21 revenue was flattered by a one-off $300m write-back which meant strong volume growth did not provide the anticipated revenue outcome. Management has highlighted further mortgage front book interest margin drag for FY22 along with a lack of institutional loan demand and weak trading conditions.

Adjusting for write-offs relating to aircraft leasing and a favourable contribution from write-backs, underlying revenue growth was just 0.4%, Macquarie points out. Hence, the stock is considered expensive.

Credit Suisse was not impressed either, as any headline growth and the investment in technology failed to be delivered to the bottom line in FY21. Given the $6bn buyback the broker envisages little relative upside for a stock is trading at 21x PE and downgrades to Underperform.

Costs

CBA is providing no guidance on costs and neither did it commit to absolute cost reductions over the medium term, although Morgans points out the bank has the best underlying cost-to-income ratio (jaws) of the majors.

This means the bank has limited scope for cost improvements and the broker assesses peers, particularly Westpac Bank ((WBC)), will close the cost efficiency gap over the next three years.

In FY22, Citi only expects revenue growth of 1% and also notes cost growth remains stubborn. With excess capital that is quantifiable and priced in, the book multiple appears at odds with a more sluggish underlying outlook and the broker concludes a downgrade to Sell from Neutral is in order.

Morgan Stanley believes the approach to costs has shifted, with the aim to achieve positive jaws, while not specifically guiding to this in FY22, rather than lower the absolute cost base.

Business Banking

The collective provision release of $632m in the second half was larger than Morgan Stanley expected but then coverage is still considered healthy, at around 1.4% of credit risk weighted assets.

Management has indicated business stress is quite muted but the broker forecasts underlying loss rates to increase to around -23 basis points in the first half of FY22, from -8 basis points in the second half of FY21, before normalising.

CBA has raised its investment expenditure to $1.8bn, up 26%, and Macquarie suggests, with $1.5bn currently captured in the profit & loss, if management wants to keep this up ongoing accruing expenses are likely. Hence, execution will be key.

The bank is high-quality but overvalued, Morgans agrees, although the results signal CBA is serious about building a leading business bank in Australia, which partially explains the elevated investment expenditure.

The broker asserts the bank can successfully take the challenge to peers in this area, particularly National Australia Bank ((NAB)), noting increases in business lending market share and business deposits market share in the results. Nevertheless, as the business bank is growing Morgans suspects the overall profile of the loan book will move up the risk curve.

Home Loans

Some interesting numbers Macquarie points to indicate around 9% of customers are in hardship assistance and interest-only loans as a percentage of total home loan balances have fallen to 12% from 16% in FY20, and 22% in FY19.

Home loans that are more than 90 days in arrears have increased and the bank expects this will continue in the short term, especially in areas affected by Sydney's recent lockdowns, while a rebound from the lockdown challenges is expected late in 2021. Despite an uptick in home loan arrears, Macquarie notes consumer credit arrears continue to improve.

Management also signalled the New Zealand economy is in a strong position and the NZ Reserve Bank is expected to raise interest rates.

FNArena's database has five Sell ratings and one Hold (Ord Minnett). The consensus target is $90.50, suggesting -15.4% downside to the last share price. The dividend yield on FY22 and FY23 forecasts is 3.7% and 3.9%, respectively.

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