Retail Malaise

Commonwealth Bank delivered a slightly weaker-than-expected first-half FY19 result due to soft revenue trends and an increase in bad and doubtful debts (BDD). Cash net profit from continuing operations of $4.676bn and revenue of $12.411bn both came in 1% below Ord Minnett’s forecasts.

 

We make the following observations:

 

  • CBA’s soft 1H19 performance mostly reflected material margin pressure in the retail segment. The retail banking net interest margin (NIM) has now fallen 17bp in the past 12 months. The difficult environment isn’t expected to turn around any time soon, and the strong returns on equity still earned by the major banks in retail banking are likely to fall from here.

     

  • Given the challenging top line, CBA has stepped up its cost-cutting rhetoric, albeit with vague language. It is now targeting a sub-40% cost-to-income (CTI) ratio, but no timeframe was disclosed and the 1H19 CTI ratio excluding one-offs was already at 40.4%. CEO Matt Comyn also flagged an absolute reduction in ‘core’ costs, but again no timeframe was given and there was no firm quantification of core costs in the half. Nonetheless, we view the commentary as both concerning, given it suggests revenue pressures are setting in, and pleasing, in that CBA is meeting this challenge head-on.

     

  • The bank’s capital position was significantly better than we expected, with most of the improvement likely to be permanent. This suggests capital management could be larger and sooner than expected, although these benefits already appear to be in the price with the stock trading at a 22% P/E premium to the other major banks versus the five-year average of 14%.

We have reduced our cash EPS forecasts by 1–2%, mostly reflecting NIM forecast reductions, leading us to lower our target price to $73.70 from $75.40. CBA looks expensive to us versus the other banks, although we acknowledge its sector-leading deposit position and capital management potential. We maintain our Hold recommendation.

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