Company Overview: Commonwealth Bank of Australia 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 includes the Asian retail and business banking operations.


CBA Details

Well Diversified Bank to Retain its Leading Position: Commonwealth Bank of Australia (ASX: CBA) is one of the largest banks in Australia with the market capitalization of circa $127.62 Bn as of November 29, 2018.  The bank operates through seven business segments i.e., Retail Banking Services (RBS), Business and Private Banking (BPB), Institutional Banking and Markets (IB&M), Wealth Management (WM), New Zealand (NZ), Bankwest (BW), International Financial Services and Other (IFS) which contributed NPAT around 56.2%, 20.4%, 12.1%, 6.1%, 11.0%, 7.4%, and 1.9%, respectively of total NPAT in FY18. During FY18, the retail banking services worked towards the management of the revenue challenges while it also managed to maintain the focus towards the efficiency. In FY 2018, Retail banking’s net interest margins stood at 2.98% representing a rise of 8 bps on a YoY basis as in FY 2017 these margins were 2.90%. This increase was supported by the re-pricing activities initiated towards the interest-only as well as investor home loans so that regulatory requirements can be managed. Another factor which supported the NIMs was favorable momentum in regard to transaction deposits. This segment’s operating expense to total banking income ratio witnessed an improvement as in FY 2018 the ratio was 30.5% while in FY 2017 it was 31.0%. In our view, the company is fundamentally strong with diversified business portfolio and strong distribution network across Australia. Further, we believe that CBA can sustain high P/BV multiple in years to come and reward the investors as the bank is on track to meet its CET1 ratio of 10.5% or more as per APRA norms by January 2020 from 10.0% at the end Q1FY19. Currently, the bank is trading at P/E multiple of 13.49x and gives an attractive opportunity to investors at current juncture. We have valued the stock using P/BV multiple and have arrived at the target price that may see an upside of the mid-single digit to low double digit in percentage term, ascribing a valuation of five-year average P/BV of 2.2x on FY20E Book Value of Equity per Share (BVPS).

Key Financial Metrics (Source: Company Reports)
 
Needle on Key Indicators

1. Decent Capital Position: The bank remained well capitalized with an overall Common Equity Tier 1 ratio of 10.0% and total capital adequacy ratio of 15.0% as per APRA norms at the end of Q1FY19. Total Risk Weighted Assets came in at $4,60,777 Mn in Q1 FY19, exhibiting modest growth of 0.5% on Q-o-Q basis. Moreover, there was a reduction in market RWA which contributed approximately 4 bps to CET1 during the first quarter of FY19. In our view, the bank in on track to meet its CET1 ratio of 10.5% or more as per APRA norms by January 2020 underpinned by the capital generation of earnings and divestment of a number of businesses as a part of its strategy to build simpler and better bank in the industry.


Decent Capital Position (Source: Company Reports)

2. Asset Quality Remains in Good Position: The Bank’s asset quality remains in good position during Q1FY19 with loan impairment of $216 Mn in Q1FY19 equated to 11 bps of Gross Loans and Acceptance against 15 bps in FY18. Home loan arrears rate was moderately improved due to seasonal factors. However, troublesome and impaired asset slightly increased from $6.5 Bn to $6.6 Bn in Q1FY19 over the prior quarter. It was mainly driven by the rise in home loan impaired assets and a small number of individual corporate assets. We believe that the bank will continue to manage its asset quality by tighter lending standard, focus on the credit recovery process, and a prudent approach to risk management.
 

Sound Credit Quality (Source: Company Reports)

3. Higher Return Ratio than Industry Median: Historically, the company maintained its RoE above 14% which is higher than the industry median of 12.6%, this signifies that the company is performing better than the Peers under the tough macro-economic condition. We expect that the company has an opportunity to improve its current RoE level in years ahead at the back of decent growth in home loan and in anticipation on favorable economic conditions.


Higher Return Ratio than Industry Median (Source: Company Reports)

4. Decent Pay-out Ratio Might Support Investors’ Sentiments: Commonwealth Bank of Australia declared a final dividend of $4.31 per share which implies a modest rise of 0.5% on the YoY basis, and it also reflects the strength of the bank’s financial performance. In FY 2017, the final dividend amounted to $4.29 per share. Additionally, the payout ratio stood at 80% in FY 2018 while in FY 2017, it was 75% and a rise is expected to be beneficial for the bank as it might lead to increased attraction from market players. Hence, we believe that the bank will continue to maintain its dividend payout policy in the range of 70% to 80% in future.


CBA’s dividends and pay-out ratio (Source: Company Reports)

Volume Growth Supported Business and Private Banking Segment: In FY 2018, the business and private banking segment of Commonwealth Bank of Australia saw robust growth in the volumes with respect to the priority sectors. During the same period, the segment’s net interest margins stood at 3.05% representing a rise on the YoY basis as in FY 2017 these margins were 2.98%. The management stated that, with respect to this segment, they would be deploying towards growth initiatives and would also take the path of innovation. Moving forward, the segment is mainly expected to witness increased coordination in the product as well as distribution functions. Moreover, another primary benefit which is expected is that the experience of the business customer is expected to improve.

 Lower markets Income Impacted Institutional Banking and Markets: Commonwealth Bank of Australia’s Institutional Banking and Markets segment recorded net interest margins of 1.04% implying a fall of 6 basis points on the YoY basis. On the other hand, segment’s operating expense to total banking income ratio rose 500 basis points in FY 2018 on the YoY basis mainly because of a major bank levy, lesser markets revenues as well as increased operating expenses. Moving forward, in regard to Institutional Banking and Markets segment, the management stated that they would be aiming towards those market segments in which they possess strong position. The initiatives towards the international presence as well as towards the product mix would help in terms of better returns as well as lesser risk.  
 
 
CBA’s Institutional Banking and Markets Segment (Source: Company Reports)

Demergers, A Step Towards Simplification: In the annual report of FY 2018, Commonwealth Bank of Australia stated that the demerger with respect to the mortgage broking as well as wealth management business would be a crucial step considering the focus on the simplification strategy. The new wealth management business would be helpful in terms of investment as well as growth prospects. The bank has maintained its clear focus towards the simplification process and, as a result, it is reducing its focus internationally.   

Credit Quality, Deposit Growth Supported CBA in Q1 2019: Commonwealth Bank of Australia’s management reflected favourable views for the September 2018 quarter. The bank’s quarter was well-supported by the business fundamentals as it witnessed favourable momentum in the deposits. Apart from this, the quarter also witnessed robust balance sheet as well as decent credit quality. However, the bank’s net interest margin witnessed a hit in the September 2018 quarter because of the competitive pressures in regard to the home loan prices as well as because of increased funding costs. The management of the bank reflected favourable views on its balance sheet and stated that its liquidity as well as funding positions were robust, and the customer deposit funding was 68% in September 2018 quarter.
 

Deposit funding (Source: Company Reports)

Drivers for Future: The management of CBA stated that they would be initiating the activities which would be more inclined towards simplification of the operating model, portfolio as well as processes. It plans to focus on its core commercial banking as well as retail business operations. The bank believes that they would be advancing the digital capabilities which could help in getting the attraction.

Moving forward, the bank plans to strengthen the capabilities like operational risk and compliance, cost reduction, data and analytics as well as innovation. Additionally, the bank’s management reflected favorable views about the digital environment and stated that in the upcoming years they would be focusing more towards the digital initiatives. The customers are also adopting digital tools at a rapid pace. The bank would continue to make the digital experience a priority. The bank would also be making deployments of the capital towards operational risk and compliance which would be improving the systems, processes as well as governance. It also plans to work towards its cost base in order to make decent deployments towards innovation capabilities.


Historical P/BV Band (Source: Company Reports)

Outlook and Stock Recommendation: In last six months, the stock has risen 3.56% and is trading at decent PE multiple of 13.49x, indicating undervalued scenario at current juncture. Two technical indicators have been applied on the daily chart of Commonwealth Bank of Australia and the default values have been considered. As per the observation, Moving Average Convergence Divergence or MACD suggests bullish momentum because the MACD line has crossed the signal line and it is moving upwards. Another indicator, Exponential Moving Average or EMA, also suggests the bullish momentum as the stock price has crossed the EMA and is moving upwards. On the other hand, the bank is well-positioned to witness strong growth momentum moving forward. The simplification strategy, increased focus on retail business and commercial banking activities as well as increased focus towards digital capabilities would be supporting the long-term growth prospects. Therefore, we have valued the stock using P/BV multiple and have arrived at the target price that may see an upside of the mid-single digit to low double digit in percentage term, with ascribing a valuation of five-year average P/BV of 2.2x on FY20E BVPS. Based on the foregoing, we give a “Buy” recommendation on the stock at the current market price of $72.430.
 

CBA Daily Chart (Source: Thomson Reuters)

 
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