Return to Base

Commonwealth Bank of Australia posted FY16 cash earnings of $9.45 billion, in line with Ord Minnett’s forecast but marginally short of consensus expectations.


Operationally, the second half of FY16 displayed some underwhelming trends, namely that each division booked lower earnings in the half with the exception of the retail banking business, which was flat courtesy of mortgage re-pricing.


Given the result was largely in line with our expectations, we have left our FY17 and FY18 earnings estimates largely unchanged.


CBA again delivered so-called positive jaws (where revenue growth exceeds cost growth) in FY16, with 5% revenue growth and 4.5% cost growth, an achievement the bank aims to repeat in FY17.


Although CBA have a strong track record on delivering on this metric, i.e. only three years of ‘negative jaws’ since 2001, we forecast ‘neutral jaws’ in FY17 with 3% growth in both revenue and costs. Combined with a rising tax rate and share count, however, this means that Ord Minnett sees no growth in EPS.


We also see CBA's core equity tier-one ratio of 10.56% at FY16 falling by around 140 basis points from higher mortgage risk weights, effective from 1 July 2016, and about $1.8 billion of wealth de-gearing, through FY17 and FY18. 


Our broader concern is that CBA’s declining return on tangible equity (ROTE) trajectory has no end in sight. Since the FY12 result, CBA’s return on tangible has declined 6.5 percentage points from 26% to 19.5%.


Meanwhile, ROTE from the bank's peers has fallen by only one-third of that amount – from circa 19% to around 16.5%. Accordingly, two-thirds of CBA’s ‘return premium’ has been eroded over the last 3–4 years, with further erosion in coming years from wealth de-gearing.


This return convergence could see CBA’s historical relative price-earnings ratio premium come under pressure, and our Hold recommendation highlights that CBA’s once-sector-leading ROTE is reverting to peers as it digests the regulatory capital headwinds mentioned above.

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