As the title suggests, today we’ll be exploring household name, Commonwealth Bank of Australia (“CBA”), who is now the largest company on the ASX after surpassing BHP in July this year.

CBA’s share price has skyrocketed 37% in the 12 months to September 2024, outperforming its major bank peers whose share prices have risen an average of 33% over the same period. CBA continues to take marketshare as it lowers prices and reported 1.7% earnings growth in the August quarter.

cba share price 12 months to september 2024

Commonwealth Bank of Australia CBA ★

  • Moat Rating: Wide
  • Fair Value Estimate: $95.00
  • Share Price: $149.32 (as at 8/11/2024)
  • Price to Fair Value: 1.57 (Overvalued)
  • Uncertainty Rating: Medium

Commonwealth Bank of Australia is the largest company on the ASX and the most overvalued of its financial peers, with its share price trading 150% over our fair value estimate.

In our view, the value divergence between CBA and its peers, ANZ, NAB and Westpac is unjustified. The bank trades at a premium given its track record of earnings and dividend growth.

Cost advantages and switching costs drive wide moat

We ascribe CBA a wide moat rating with its dominance in the Australian and New Zealand market. The company’s key funding cost advantage stems from customer deposits contributing 77% of overall funding. While fixed term deposit rates are typically more expensive, customer funds held in transaction and saver accounts generally accrue little or no interest.

CBA also operates on a much better cost-to-income ratio than smaller competitors and most overseas non-investment banks. Larger banks can disperse fixed costs such as compliance, technology and branches to increase operational efficiencies.

Customer stickiness stems from the ability to offer multiple products, not only boosting profitability per customer but also bolsters switching costs. Bank customers often resist moving financial service providers due to the lack of perceived benefit and administrative hassle of opening/closing accounts.

Our valuation

Our fair value estimate for CBA is $95 per share as loans grow roughly in line with the market over medium term, we assume total lending growth averages 4% over the next five years. We expect return on equity to consistently perform above the bank’s 9% cost of equity, with return forecasted at ~15% through to fiscal 2029.

Financial institution valuations are unique as we cannot ascribe typical valuation multiples such as earnings before interest, tax, depreciation and amortization to accurately reflect true performance. Tax, depreciation and amortization are all core to value creation for financial institutions, therefore must be accounted for in earnings.

The net interest margin is one of the key indicators of a financial institution’s profitability and growth. The metric is used to calculate the spread of earnings earnt on interest in loans compared to earnings paid by interest on its deposits. Morningstar expects net interest margin to stabilize to around 2.05% by fiscal 2026, reflecting loan repricing, increased competition and higher wholesale funding costs.

CBA reported a common equity Tier 1 capital ratio of 12.3% at June this year making it one of the world’s few highly rated banks that continues to generate capital organically.
The company’s home loan book is high quality with a 43% average loan/valuation ratio for Australia and around 80% of customers ahead with payments.

With the bank trading on a forward price-to-earnings multiple of over 21x and a fully franked dividend yield under 4%, the valuation leaves little room for disappointment.

Impending rate cut implications

Unsurprisingly, this week saw the Reserve Bank of Australia hold interest rates at 4.35%, officially marking one year since the Reserve last lifted rates. Despite inflation having “fallen substantially” since its 2022 peak, the RBA stated that it remained too high at 3.5% in September quarter end.

The body released an analysis showing that core inflation in Australia was the second highest among major advanced economies, just behind the United Kingdom who recently cut rates by 0.25% in August.

core inflation among major advanced countries
Source: Reserve Bank of Australia. September 2024. 

In August this year CBA cut interest rates on new home loans after being widely criticised for slashing the rate on term deposits. The nation’s largest lender was the last of the four major banks to slash interest rates for new borrowers. 

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Terms used in this article

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company's future cash flows, resulting from our analysts' independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.