Commonwealth Bank: Q1 trading update

Author name:: By Nathan Lead
Job title:: Senior Analyst
Date posted:: 16 November 2022, 7:00 AM
Sectors Covered:: Infrastructure, Utilities, Banks

Commonwealth Bank's (ASX:CBA) Q1 update showed strong growth in the high quality net interest income but weakness in the lower quality non-interest income and loan impairment charges.
We downgrade forecasts and valuation reflecting Q1 performance.
HOLD retained. With a (login to view) target price. FY23F cash yield of 3.9% (5.5% incl. franking).

Event

CBA released its Q1 trading update and Basel III regulatory disclosures. Q1 cash NPAT grew +2% above the 2H22 quarterly average.

This is tracking at or mildly above consensus expectations for 1H23, but below our more bullish forecast that was for c.4-5% growth.

Analysis

Net interest income (c.80% of income) delivered growth (+16% on pcp) broadly in-line with what we expect for 1H23F. Key drivers are higher margins and volumes, rising rates on replicating portfolio and equity hedge (swaps portfolios), and more days in the period than the pcp. We make no changes to these forecasts.

The more volatile non-interest income (-17% on an underlying basis, or -31% after non-repeat of the gain on sale of HZB shares in 2H22) is tracking notably weaker than what we had targeted.

CBA references lower net profits from Chinese bank investments, higher flood claims, and unfavourable derivative valuation adjustments, partly offset by volume-based growth in banking fees. We downgrade our forecast for this revenue category by 8% for FY23-25F.

After adjusting for the one-off accelerated software amortisation in the pcp, CBA indicated cost growth of c.4%. CBA noted higher staff costs offset by lower software amortisation and occupancy costs. We have increased our cost forecasts by 1% across FY23-24F and by 3% in FY25F.

On a pre-provision operating profit (PPOP) basis, Q1 earnings growth was +12%. Forecast non-interest income and cost changes see us downgrade by 3-5%, such that we now forecast PPOP lifting 14% in 1H23F and by 18% in FY23F.

We then expect PPOP growth to slow to 2% in FY24F and to decline by 3% in FY25F as the NIM uptick begins to fade and is outpaced by cost growth.

Loan impairment expense of $222m in Q1 (10 bps of gross loans) compared to a provision release in 2H22 of $282m. We still assume that the loan impairment expense will normalise upwards to a long-run loan loss rate of 17 bps by FY24F.

However, the Q1 ramp-up was quicker than expected, so we factor in materially larger charges for FY23F. Having said that, asset quality still looks strong (ultimately supported by historically low unemployment rates).

Key regulatory capital metric Common Equity Tier 1 Capital Ratio exited Q1 at 11.1% and looks to be tracking towards our end-1H23 forecast of c.11.5%. We expect uplifts to the ratio as the Interest Rate Risk in the Banking Book unwinds over coming years and from the impact of APRA’s revised capital adequacy framework (for these two combined NAB estimated it would benefit by c.85 bps).

CBA expects to operate with a post-dividend CET1 ratio of >11% under APRA’s new framework from January 2023. We estimate CBA will produce c.$6bn of surplus capital over coming years from which it can undertake further buybacks across FY24-25F (in addition to completion of its current $2bn buyback program).

Forecast and valuation update

Cash EPS downgrades of c.7% for FY23F and 3-4% for FY24-25F. DPS downgrades of 2-5% across FY23-25F.

DCF-based 12-month target price reduced (login to view). We estimate the current share price implies 2.5x P:BV (end-FY22A) and 17.5x PER (FY23F). Our target price implies 2.1x P:BV (end-FY23F) and c.16x PER (FY24F).

Price catalysts

1H23 result on 15 February 2023. Key economic data releases and RBA policy cash rate changes. Monthly APRA and RBA lending and deposit balance and interest rate data releases. Share buyback and dividend announcements.

Risks

Interest, inflation, and foreign exchange rates.
Credit risk (key considerations being unemployment and value of collateral).
Competition for loans and deposits.
Regulatory risk.
Liquidity and funding risk.
Cybersecurity.

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