What next for the largest company on the ASX?
After a historic rally in 2024, what lies ahead for this overvalued banking titan?
Mentioned: Commonwealth Bank of Australia (CBA)
Aussie heavyweight Commonwealth Bank ("CBA") surpassed BHP last July to become the largest company on the ASX.
2024 was a stellar year for the big four banks with share prices rising 27% on average in the year, beating the overall market by 20%. After the rally, there is little upside left to be found in the banks with most above fair value. CBA followed suit however blew the other players out of the water with a 35% rise in share price, making it one of the most expensive banks in the world on a price/earnings basis.
Commonwealth Bank of Australia CBA ★
- Moat Rating: Wide
- Fair Value Estimate: $98.00
- Share Price: $144.80 (as at 12/03/2024)
- Price to Fair Value: 1.48 (Overvalued)
- Uncertainty Rating: Medium
Where does CBA stand after earnings?
CBA’s latest earnings somewhat exceeded our expectations for revenue growth and bad debt expenses, but disappointed on cost growth. Profit increased by 2% on last year and 7% on the second half of fiscal 2024. This was primarily driven by loan growth, net interest margin improvement and lower bad debt expenses.
The net interest margin (“NIM”) 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. With an underlying NIM improvement of 1%, we are seeing a stabilisation which is expected to continue.
Whilst our medium-term forecasts are largely maintained, we increase our fiscal 2025 forecast by 2% which implies full year growth of 7%. Morningstar increases our fair value estimate for CBA to $98 per share, reflecting a 3% increase on the previous estimate.
Growth prospects
Undoubtedly housing is dominating the Australian credit sector, accounting for almost two third of outstanding loans. Australia mortgage loan and business lending growth was 1.2x faster than the market. In the half, CBA wrote more home loans directly with only 34% of new lending going through lower-returning third party brokers, compared to 75% for the market.
The past few years of cash rate increases materially increased the risk of higher credit losses and reduced demand for credit. We now expect modest credit growth and margins improvement in fiscal 2025.
Australian housing is expensive with debt/household income ratios at all-time highs. We believe underwriting standards, lender’s mortgage insurance, high loan prepayment and full recourse lending are amongst the many variables that will mitigate potential losses from mortgage lending.
Some investors consider the strong emphasis on home loans as a weakness, but we argue it is a key strength. Weighing to home loans and the high portfolio of customer deposits reduce risk on bad debts and sudden changes to funding costs. A severe economic downturn in Australia or housing collapse could force sharp falls in earnings and dividends, however it would likely put even more pressure on smaller challengers.
How do the shares look?
On a forward price/earnings ratio above 25, 3% dividend yield and price/book ratio above 3.5, Morningstar analyst Nathan Zaia believes CBA shares are materially overvalued. Whilst a premium to peers is warranted due to the lower cost of funding and superior operating efficiency, the gap is extreme.
CBA reported a common equity Tier 1 capital ratio of 12.2% at Dec 31 2024, 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 42% average loan/valuation ratio for Australia and around 81% of customers ahead with payments.
CBA is well positioned to preserve its legacy of reliable dividend growth. Strong capital position and organic capital generation support our forecast of a $5 dividend for fiscal 2025. The first half dividend yield implies a payout ratio of 73% which is expected to lift to around 80% on a full-year basis in fiscal 2025 and over the medium term.
We raise our fair value estimate for CBA to $98 per share, which means it is currently trading 150% over our estimate.
