Joseph Taylor: Hi, Nathan. So, Commonwealth Bank have reported their full year results. What were the main headlines?

Nathan Zaia: Yeah, I think it wasn't quite the record of last year, but still a very good result. We had the top line was basically flat. So, a little bit of loan growth, but margins under pressure, similar sort of trends that we've been seeing for a little while now with the competitiveness in mortgages, although that did ease a little bit over the year. We've had deposit switching, so customers going from transaction accounts to term deposits and savings accounts to get that bit of extra interest, and that's hurting banks' margins. And CBA also commented that more of its customers in those savings accounts are getting that extra bonus. So just all in all that weighed a little bit on margins. Bad debt is still very low and operating expenses growing at 3% to 4% range. So, all in all, a pretty sound result.

We saw the dividend come in at $4.65 for the full year, which was a little bit higher than what we had at $4.60. But yeah, all in all, strong capital position, well-provisioned. I think the only one blemish if there is one on the result is their loan growth. So, they did grow below market, so lost a little bit of market share in Aussie home loans. And I think that was a strategic thing to do and was the right thing to do just to stop that pricing pressure. So, if CBA wanted to continue to be aggressive, just would have drove down margins for the entire industry. But in the second half, they did actually return to growth. So, it does show if they choose to and the returns are there, they can reignite that growth.

"The results definitely showed signs that households are under pressure"

Taylor: There's been a lot of attention on how the Australian consumer and how Australian households are dealing with higher rates and a potential slowing in the economy. Were there any clues there in the results about how households are dealing with everything?

Zaia: Yeah, I mean, CBA is the largest household deposit holder. So, I think that does give you good insight. We see the total offset and redraw balances continue to grow. But I think that it kind of masks the uneven nature of the impacts of higher inflation and higher interest costs. So those borrowers that are under 44s, under 45s, they see their savings declining in the last few months or the three months to June. Whereas you have the older age groups that have more savings, their savings continue to grow. And I guess the flow on impact from that we are starting to see – we're not starting but continuing to see arrears rise, so people missing their repayments. That continues to rise as savings is depleted. But with the arrears rates, they're back to about historic averages now. So not alarming and probably still will trend higher as unemployment looks like it's going to rise from here as well. But not at an alarming rate. And I guess the other thing to point out, that doesn't automatically mean the same amount of loss for the bank because a lot of those borrowers still do have equity as well. So, I mean, there are signs that households are under pressure definitely showing in the bank results as well.

"They are holding a lot more provisions than we think they would naturally hold through a cycle."

Taylor: So arrears are something to keep a close eye on going forward. But you also mentioned that there's a lot of provisions there to cushion them from losses?

Zaia: Yeah. So, you can look at provisions in a couple of different ways. But we look at it as a percentage of their loans or percentage of the risk weight. So different risk of loan categories means different amount of capital you need to hold against it. The banks are holding extra to what they normally would through a cycle. So, they increased them during COVID and then they sort of didn't need them back then, but they've sort of kept them for the uncertainty of higher inflation and the flow through of higher rates onto the economy. So, they are holding a lot more than we think they would naturally through a cycle. So that provides a buffer to the P&L. And if they don't end up needing them, they'll get released and you'll actually have lower bad debts to loans over the next few years as well for that reason.

"If earnings do come under pressure, I wouldn't be surprised if they use that surplus capital to keep the dividend growing at least."

Taylor: Their capital position that's far above the regulatory capital, what's required of them from the Basel framework, for example. A lot of people have seen that as a potential buffer for future dividend growth and more share repurchases. Is it actually a case of them holding onto those reserves just in case the economy does turn?

Zaia: Yeah, I mean, so 11 to 11.5 [per cent] would be the target. They're holding above that. So, I think 11.5 is a healthy buffer over what they need. So, they've got $2.30 per share above that. So, I think that probably does get returned over time. I don't think CBA is in a rush to return it to shareholders. They've got the on-market buyback that's open. So that's up to a billion dollars. And we've seen they're paid out close to the top of their dividend payout ratio. I wouldn't be surprised if earnings do come under pressure that they use that surplus capital to keep the dividend growing at least.

"I am yet to meet anyone that thinks CBA is cheap..."

Taylor: So, the financial position is fairly strong. The operating results were nothing to be concerned about. But it's probably true that CBA looks expensive on almost every metric for a bank when you compare it to European banks and even the ones at home. What does it need to do to justify that kind of valuation going forward?

Zaia: Well, I don't know how it does. I am yet to meet anyone that thinks it's cheap. I don't think the actual earnings at the moment are what's driving the share price. The actual result was fine as we said, and it shows the quality of the bank, like the lowest cost-to-income ratio, highest ROE, digital advantages, steady dividends over time, loan loss rate. Everything is great, right? But at what price? So, our five-year forecast is around 6% EPS to EPS growth per year, which is fine, but it's not shooting the lights out. But it's on a P/E of over 20, dividend yield I think 3.7. We currently have it at price to book of 3 times. So, it is expensive. And it's not the only ASX-listed bank, right? We have three other major banks, which we have wide moat ratings on. And Westpac and ANZ are on P/Es of 12 to 13 times versus 21 for CBA. So sure, CBA is better quality. Maybe it deserves a premium. But how much of a premium? So, I don't think investors that want bank exposure in Australia have to buy CBA as well.

So, I mean, there's been a lot of discussion around what is driving the price and whether it'd be passive ETFs, active managers trying to cut their underweight positions. And then on the other side, you have the retail shareholder base on large capital gains that don't want to sell. So, there's not the selling to satisfy the buying. So, there's a lot of different reasons. I don't think it's one. It's probably a combination of all of them. But at the end of the day, I think the fundamentals is all we can use to try and work out what you should pay for the stock. And we currently value CBA at $95. So quite a long way off the mark. And like I said, I think we have a fairly positive view of the outlook. It's a low growth environment, I think, for CBA.

Commonwealth Bank of Australia

  • Star rating:★
  • Economic moat: Wide
  • Fair Value estimate: $95 per share
  • Share price on August 16: $138.13

Investments such as shares and funds should only be considered as part of a deliberate investing strategy. Go here for a step-by-step guide to crafting yours.

Related articles and insights:

Get more Morningstar insights in your inbox

Terms used in this article

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.

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.

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 more about how to identify companies with an economic moat, read this article by Mark LaMonica.