Commonwealth Bank delivered a slightly better-than-expected first-half FY20 result, but the real positive was the bank’s much stronger capital position, which provides more fuel for capital management. Pre-provision profit was 1% ahead of Ord Minnett’s forecast, excluding remediation costs. Most line items were very close to our estimates, with the exception of group net interest margin (NIM) which expanded by 1bp half-on-half versus our assumption of a 1bp contraction.
We suspect CBA will first wait for other asset sales to be completed before going down this path. In addition, the potential scale of any capital management, which we estimate could be as much as $7bn, suggests a package of management initiatives is now more likely.
CBA’s core equity tier-one capital (CET1) ratio surprised strongly at 11.7% versus our expectation of 11.1%, $3bn more than our forecast, on a series of unexpected positives. This provides much greater capacity for capital management, although the $1.5bn franking credit balance is a limiting factor. Given this, we now expect a combination of an off-market and on-market share buyback when remaining asset sales are completed.
Disappointingly, underlying costs rose again. Since CBA first set out its “absolute cost reduction” goal a year ago, operating expenses (excluding notable items) have increased 4%, so the target is actually moving further away.
We have increased our cash earnings forecasts by an average of 2% over the FY20–22 period due to slightly higher non-interest income and lower bad debts. Cash EPS upgrades have been stronger, at about 3% in FY20–21 and 4% in FY22, given the increase in our buyback assumption to $7bn.
Despite the more resilient NIM trends, we find CBA’s current valuation metrics very hard to justify. The stock is trading on a price/earnings (P/E) multiple of 17.5x FY21E earnings, a 40% P/E premium to its peers, and on a price/book value ratio of 2.2x for a return on equity of 13.5%. That said, the prospect of further capital returns could be enough to sustain a share price that is trading on such stretched valuations. On balance, we maintain our Hold recommendation and have lifted our target price to $78.20 from $74.80.