Company Overview: Commonwealth Bank of Australia (ASX: CBA) is a provider of financial services, including retail, business and institutional banking, funds management, superannuation, general insurance, broking services and finance company activities. The Company's segments include Retail Banking Services, which provides home loan, consumer finance and retail deposit products; Business and Private Banking, which provides banking services to relationship managed business and agribusiness customers; Institutional Banking and Markets, which services its corporate, institutional and government clients; Wealth Management segment, which includes global asset management, platform administration, and general insurance businesses; New Zealand, which includes the banking and funds management businesses operating in New Zealand; Bankwest, which offers a range of deposit products, and IFS and Other Divisions, which include the Asian retail and business banking operations.


CBA Details

Commonwealth Bank of Australia (ASX: CBA) is fundamentally strong backed by a nationwide distribution network of 1,267 branches and 4,253 ATM branches in Australia. The bank has a deep penetration in the Australian Banking industry, serving 16.1 Mn customers in addition to 6.5 Mn digital customers. We believe that CBA is playing on sound infrastructure to achieve growth by simplifying the customer-based operations and has an ability to overcome challenges arising from the royal commission. Moreover, the bank will continue to pay cash dividends at strong and sustainable levels going forward while there may be some short term headwinds.


Source: ASX, * As on 27 September 2018

Core Housing Finance Portfolio Provides Momentum in a Changing Economic Scenario
CBA has seen its total loan growth at a CAGR of 5.4% during FY14-FY18. CBA’s total loan as of FY18 comprises of 67.1% towards housing loan and the balance towards non-housing loan. Loan growth for FY18 grew 1.5% on Year-on-Year basis while Deposits de-grew by 1.5% during the same period. Healthy traction was seen in home loan at 3.7% Y-o-Y. Uptick in growth in Business loan is expected in years to come. With the rising government initiatives and reforms in the affordable housing space, we believe the company has a healthy outlook in years ahead at the back of balance sheet position, strong loan book and consistent dividend payout ratio of over 75%. Moreover, the outlook for Australian economy is decent with GDP growth expected to be around 2.7% for the remainder of 2018 and 2019. The Australian banking industry has performed well over the past decade, underpinned by favorable credit market conditions and stable economic conditions. On this note, CBA has historically posted strong total shareholder returns, and has outperformed the Australian market and peer banks.

As per the latest Commonwealth Bank Business Sales Indicator (BSI), Australia has witnessed spending growth for consecutive twenty-six months with a rise of 0.9 per cent in the month of August. The annual trend shows that growth in sales hits new four-year high of 11.4 per cent, up from 10.7 per cent in July. Thus, growth in consumer spending, decent employment data and positive consumer sentiment while wage growth is still at low level, can pave a decent path for CBA.
 
 
Loan Growth and Deposit Growth (%) (Source: Company Reports)

Decent 2018 Financial Performance & Strong Balance Sheet
CBA in FY 18 has delivered 4.8% fall in the cash net profit after tax on the prior year to $9,233 million. The cash net profit was impacted due to a number of one-off items that include a $700 million non-tax deductible expense for the AUSTRAC civil penalty. These one off items also include the Return on equity on cash basis, that fell by 160 basis points to 14.1% due to the combination of lower profits and higher levels of equity as the Bank is working towards APRA’s ‘unquestionably strong’ capital target, which is effective from 1st January 2020. Further, one off item included the earnings per share on cash basis, that was 528.6 cents, which is a fall of 6.2% on the prior year. Excluding one-off items, cash NPAT grew 3.7% and the investors were encouraged by the fact that without the one-off expenses, the bank would have reported a $10.01 billion cash profit.

Moreover, in 2018, operating income excluding one-off items rose 3.4% to $25,670 million driven by a 4.5% rise in net interest income, with higher funds and insurance income partly offset by a reduction in other banking income. Net interest income excluding one-off items grew due to 2.3% growth in average interest earning assets and a 2.2% increase in NIM (up 5 basis points). NIM expanded 5 basis points to 2.15% primarily due to the benefit from repricing of interest-only and investor home loans, the funding benefit from deposit repricing and an increased proportion of low cost funding through transaction deposits which was partly offset by the impact of the major bank levy and higher wholesale funding costs. The bank’s Funds management income in 2018 grew 9.3% to $2,091 million driven by a rise in the amount of funds invested leading to positive net flows and positive market returns on invested funds. Additionally, during FY 18, CBA’s Bank’s Liquidity Coverage Ratio was 131%, up from 129% at 30 June 2017 and is well above the regulatory minimum of 100%. The Bank’s Net Stable Funding Ratio (NSFR) is of 112%, which rose up from 107% at 30 June 2017 and is also well above the regulatory minimum of 100%. CBA has the leverage ratio of 5.5% on an APRA basis, that rose up from 5.1% at 30 June 2017. CBA’s CET1 ratio (APRA) is of 10.1%, compared with 10.4% at 31 December 2017 and 10.1% at 30 June 2017. The bank has maintained capital ratios well in excess of regulatory minimum capital adequacy requirements at all times in 2018.

Key Financial Metrics:

(Source: Company Reports, Thomson Reuters), *excluding the impact of the AUSTRAC civil penalty

Portfolio Review and Strategic Decisions
CBA is already making progress on divestments of the life insurance businesses in both Australia and New Zealand.  The bank has divested Sovereign and the divestments of CommInsure Life and BoComm Life are subject to regulatory approvals, which will provide a further expansion in the bottom line. The bank has planned to complete the sale by December 2018. Further, PT Commonwealth Life is under the strategic review. Moreover, CBA is also making strategic review of the general insurance business and the stake in Vietnam International Bank. The bank has already decided to exit the TymeDigital business in South Africa. Moreover, CBA has announced the demerger of the Wealth and Mortgage Broking operations.

CBA has undertaken a number of strategic decisions to maintain the strength in capital, funding and liquidity. The bank has issued new long-term wholesale funding that has a weighted average maturity (WAM) of 9.0 years, which brought the portfolio WAM to 5.1 years (against 4.1 years of FY17). As a result, the annual funding requirement for future years is reduced (as average annual maturities are lower), which reduced the associated refinancing risk from potentially unfavorable funding conditions. Further, CBA replaced the short-term for long-term wholesale funding actively, with long-term wholesale funding now accounting for 67% of total wholesale funding (up from 60% at 30 June 2017). Moreover, the level of liquid assets and customer deposit growth are properly managed by the bank to strengthen the funding and liquidity positions as reflected by increases in the Liquidity Coverage Ratio and Net Stable Funding Ratio. CBA has taken a conservative view in the application of the AASB 9 Accounting Standard and focused on capital generation in order to achieve APRA’s ‘unquestionably strong’ capital target. Meanwhile, CBA has appointed Paul O’Malley to the Bank’s Board of Directors, effective from 1 January 2019. Brian Long will remain on the Board until the end of the calendar year and will retire at 31 December 2018. Andrew Mohl will retire from the Board at the conclusion of the 2018 Annual General Meeting.

Needle on Key Indicators


I.               NII growth accelerates as NIM improves
Bank has posted 4.5% rise in NII at $18,341 Mn for the period ended June 2018, driven by the repricing interest-only and investor home loans in order to manage regulatory requirements, selective growth in lending and an increased proportion of low-cost funding via transaction deposits; partly offset by the impact of the major bank levy. Meanwhile, the Other banking income declined 3.7% to $4,590 Mn in FY18 over the prior period. NIM of the bank improved by 5bps to 2.15% in FY2018 from 2.10% in FY2017.
II.             Rise in Expense-to-Income Ratio
Total operating income of the bank increased 2.6% to $25,907 Mn in FY2018, while the operating expenses surged 9.2% to $11,599 Mn, leading to increase in expense to income ratio to 44.8% in FY2018 from 42.1% in FY2017. The ratio is a key indicator to know about the company’s costs in relation to its income. Operating expenses increased 9.2% due to the AUSTRAC civil penalty and one-off regulatory costs incurred during the period.
III.           Dividend pay-out looks stable around 75%
CBA has declared a final dividend of $2.31 that brought the total dividend for the year 2018 to $4.31, equivalent to 80.4% of the CBA’s cash profit that includes the AUSTRAC civil penalty. While, excluding the AUSTRAC civil penalty, the bank’s dividend payout ratio was 74.9% of cash NPAT, which is within the Bank’s target ratio of 70% to 80%. Backed by healthy balance sheet and steady growth in the loan book, the company was able to consistently increase/ maintain the dividend and dividend payout ratio. We further expect the company to increase the dividend in years to come while maintaining the dividend payout ratio around 75% though some short-term challenges or declines may be seen given the prevailing investigations in the sector.


Dividend pay-out to remain stable at around 75% (Source: Company Reports)

IV.           EPS and Book value to remain accretive:
The company has seen its EPS growing at a CAGR of over 0.2% during FY14-FY18. We further expect the EPS to grow in the upcoming period at the back of improving bottom-line numbers. On the other hand, its book value has grown at a CAGR of over 8.4% during FY14-FY18.


 EPS and Book Value Trend (Source: Company Reports)

Joins Regtech group to improve compliance
Commonwealth Bank of Australia (ASX: CBA), which operates through the segments comprising of Retail Banking Services, Business and Private Banking, Institutional Banking and Markets, Wealth Management, New Zealand, BankWest, and IFS and Other Divisions, has been severely tested due to a series of conduct and compliance issues in FY18. As part of the settlement with the Australian Transaction Reports and Analysis Centre (AUSTRAC), CBA had paid a civil penalty of $700 million to focus on improving the risk and compliance capabilities, and to continue to work constructively with AUSTRAC. CBA is participating transparently and fully in the Royal Commission through the process of scrutiny. Royal Commission is inquiring about the conduct of banks, insurers, superannuation funds and other financial services institutions, and is assessing the effectiveness of existing regulatory frameworks and mechanisms. The commission’s final report is due by 1 February 2019, and an interim report is due by 30 September 2018. Meanwhile, CBA is taking steps to emerge from the shadow of its money laundering scandal. The bank has put one of its senior managers (Jasper Poos) on the board of the RegTech Association, to develop new anti-money laundering and compliance systems. Therefore, working with the RegTech Association could help CBA to remove technology gaps and improve its risk management.

Stock Performance and Analysis with Recommendation
CBA stock is trading at A $70.080 level, has an immediate resistance at $76.2 and support at $67.5 level. Its Return on Equity (RoE) is an important indicator to know about the Bank’s profitability. It represents the net profit generated as a percentage of the equity shareholders have invested and CBA’s ROE remains strong, though it has declined a bit in FY18 by 160 bps to 14.1% against the prior year due to regulatory requirements for higher levels of capital. Meanwhile, CBA has fallen 1.4% in one month as on September 26, 2018 and is trading at a reasonable P/E of 13.13x. Moreover, the outlook for Australian economy is positive with GDP growth expected to be around 2.7% for the remainder of 2018 and 2019. CBA finds support from this and has also historically posted strong total shareholder returns. With strong fundamentals and capability to mitigate challenges from ongoing investigations, we give a “Buy” recommendation on the stock at the current price of A $70.080.
 

CBA Daily Chart (Source: Thomson Reuters)

 
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