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Commonwealth Bank Of Australia

Jan 28, 2014

CBA:ASX
Investment Type
Large-cap
Risk Level
Action
Rec. Price ($)
Company Overview – CBA is Australia’s second oldest and largest bank with operations spanning Australia, New Zealand and Asia. Its core business is the provision of retail, business and institutional banking services. It is also a major fund manager and the second largest life insurer in Australia. CBA operates the largest financial services distribution network in the country. The strategy which has been stable and successful, emphasises a well-managed, diversified business model, strong balance sheet, stable financial platform and conservative underwriting. Its operating segments include retail banking services, Business and Private Banking, Institutional Banking and Markets, Wealth Management, New Zealand, Bankwest and other.
Analysis – CBA will report its interim results on Wednesday 12th February. We believe that the underlying trends in first half of FY2014 to be unchanged since June 2013. Annualised revenue growth is expected to be around 6% underpinned by strong performances in the flagship Australian retail banking and the wealth management businesses.

CBA is a low risk bank trading at attractive dividend yield of around 5%. At the height of the global financial crisis during 2009, EPS and dividend fell just 14% demonstrating the strength of the balance sheet and the diversity of the revenue. This is not a stock where an attractive dividend yield signals high financial risk, in CBA’s case the yield signals moderate earnings growth due to slow credit growth and pressure on funding costs. CBA’s strong focus on home loans is not a weakness but a strength.
U.S style housing depression in Australia is very unlikely, with the most likely outcome an orderly and modest cooling in house prices. Earnings growth forecasts remain robust. Compared to other global banking stocks this is a low risk play with  a very strong balance sheet and sustainable competitive advantages.
The financial crisis exposed some poor commercial lending decisions but in the long run, bank has consistently grown shareholder wealth in favourable economic times. Commonwealth Bank weathered the global financial crisis as one of the few highly rated banks in the world. The bank’s yield story remains intact with expectations of a sustainable 70% interim dividend payout ratio and an overall full year target payout ratio in the 70-80% range. This highlight’s CBA’s exceptional internal capital generation capability in a low credit growth environment and in addition to current stringent capital requirements as dictated by APRA.

APRA has released an information paper on domestically systemically important banks(D-SIB): designating the four major banks as D – SIB but importantly not Macquarie bank, requiring D-DIB’s to each hold an additional 1% of Tier 1 common equity capital by 1st January 2016 which is on top of the 7% minimum capital conservation buffer.


Whilst APRA’s D-SIB requirement in the near term is negative for the major banks, strong capital generation particularly through Dividend Reinvestment Plan should make the transition manageable. Despite major bank capital levels under scrutiny we do not expect any adverse surprises, with existing capital levels and organic capital generation sufficiently strong to outweigh the need for any new capital issues. Strong competitive advantages, increasing profitability and moderate loan growth support our long term positive view on CBA.



Price Price % Change
     Close: 74.13 (28-Jan-2014)      3M: (1.11%)
     52 Wk High: 79.88 (08-Nov-2013)      6M: 2.52%
     52 Wk Low: 63.90 (26-Feb-2013)      1Y: 18.18%


CBA is a large and highly leveraged financial institution operating across a number of markets and as such is subject to the risk changes in the general business and economic conditions within these markets. A change in these conditions could include changes in interest rates, inflation, unemployment, monetary supply, changes in foreign exchange rates and the health of the general economy. CBA also faces the risk of regulatory changes and increased competition which could affect the profitability of the group. A key risk that financial institutions face is associated with extending credit to other parties. Less favourable business conditions could cause potential losses from loans to increase putting pressure on the group’s capitals. CBA also faces operational risk from running such a large and complex business.
The main current influence on earnings growth is weak credit growth, a product of household risk aversion and delays to business plans for capital expenditure. Funding cost pressures are constraining interest margins.



Dividend      
Yield 5.26 FY Payout Ratio 75.4 FY
  5.85 5yr Av   76.7 5yr Av


CBA’s core banking modernisation or CBM program is a major transformation project replacing antiquated, unreliable and inefficient 40 year old IT systems. CBM is driving competitive advantage by enabling faster and targeted marketing campaigns, real time banking and smoother more efficient customer experience. Commonwealth Bank leverages its large branch network to increase cross sell, for example of wealth management and insurance products. Commonwealth bank’s large scale generates substantial cost advantages over smaller banks and non-banks.

CBA (AUD, Millions) 2013 2012 2011 2010 2009
Interest Income, Bank 34,739 38,258 37,477 32,464 31,519
Total Interest Expense 20,805 25,136 24,883 20,402 21,218
Net Interest Income 13,934 13,122 12,594 12,062 10,301
Net Income After Taxes 7,693 7,106 6,410 5,680 4,753
Gross Dividends - Common Stock 5,863 5,303 4,975 4,474 3,409
Despite industry headwinds CBA’s competent management, diversified revenue stream along with a strong and stable balance sheet continue to consistently deliver solid financial results. Costs are under control and supporting earning during a period of weak revenue growth. Growing economies of scale make ongoing gains in cost efficiency likely. Commonwealth bank comfortably meets the BASEL 3 capital standards applying from 2013. The core banking modernisation program is adding a distinct competitive advantage. The fully franked dividend yield is attractive and should support the share price. On the other hand cost of wholesale funding remains relatively high and price competition for home loans is vigorous. Banking fee income is under pressure from consumer resistance to fees. Credit growth in Australia is still weak across all categories. After taking into consideration all the above factors we would be putting a HOLD recommendation at the current price of $74.13 for the clients currently holding the stock in their portfolios.


Disclaimer
Kalkine provides general advice on securities. Kalkine does not provide advice that takes into account your, or anybody else’s investment objectives, financial situation or needs. We strongly suggest that you should make your own enquiries about any investments and we strongly suggest you seek advice before acting upon any recommendation. Kalkine Pty Ltd has made every effort to ensure the reliability of information contained in its newsletters and websites. All information represents our views at the date of publication and may change without notice. Employees and/or associates of Kalkine Pty Ltd may hold one or more of the stocks reviewed on this website. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine Pty Ltd currently hold positions in:  BHP, BKY, KCN, PDN, and RIO. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations.
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