Elephant in the Room

The second-half FY19 result from the Commonwealth Bank of Australia was weaker than Ord Minnett’s rebased forecasts, with cash net profit 3% below our numbers due to a similar-sized miss on costs. Stripping out one-off items put the disappointing performance in a worse light, with pre-provision profit down an estimated 5% half-on-half and cash net profit down 7% excluding the day count impact.

 

As expected, much of the focus was on prospects for cost savings and capital management. There was little news on either front, although we see the challenging revenue environment as requiring greater focus on both.

 

We sense a degree of urgency from CBA’s management team on executing a tax-effective share buyback. We see it as prudent for CBA to await clarification on new capital rules by the Reserve Bank of New Zealand, as well as the response from the Australian Prudential Regulation Authority, before doing so. CBA’s commentary, however, suggested to us the bank would not necessarily wait for either. We still expect a $3.5bn buyback early next calendar year, but wouldn’t rule out something larger, and/or sooner.

 

We have also allowed for a 1% reduction in absolute underlying costs by FY22. Despite these positives, however, we have reduced our cash net profit forecasts by 4% in FY20 and 3% in FY21 due to an increase in net interest margin pressure with declining cash rates.

 

CBA is looking very expensive at a price-to-book value ratio of around 2.0 for a return on equity of only 13.5%. We appreciate the valuation issues, although we note the total estimated 12-month return is barely negative, even with our new target price of $74.20 (reduced from $76.00) being below the current share price. On balance, this has led us to maintain our Hold recommendation, although CBA is our least preferred of the big four banks.

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