Commonwealth Bank: Was 1H23 peak earnings in the cycle?
About the author:
- Author name:
- By Nathan Lead
- Job title:
- Senior Analyst
- Date posted:
- 16 February 2023, 9:00 AM
- Sectors Covered:
- Infrastructure, Utilities, Banks
- Commonwealth Bank (ASX:CBA) the 1H23 result was solid, with strong operating profit growth partly offset by the reversal of credit impairment releases into expensing. Cash returns were lifted via higher dividends and buybacks. The key negative was the seemingly early peak in the NIM and concerns for a weakening domestic economy and mortgagor.
- 12 month target price lifted 3% to (login to view). The forward dividend yield (including the value of franking credits) offsets the price downside to our PT.
- Retain HOLD as a core long-term major bank position in portfolios. However, investors may consider trimming overweight positions given concerns on a weakening domestic economy and peak cycle earnings.
1H23 result delivers solid growth and increased cash returns
Cash EPS growth (+7% on 2H22) was broadly in line with expectations. Growth in pre-provision operating profit (akin to a bank’s EBITDA) was +18%, driven by 4% net loan growth and 22 bps NIM improvement partly offset by cost growth (wages and general inflation, IT costs). The less buoyant EPS growth was due to a significant normalising swing in loan impairment expenses.
ROE lifted 80 bps to 14.1% (1H23 annualised), or 13.7% on a trailing 12 months basis. This is well above our estimate of CBA’s cost of capital, thus value creation.
The interim DPS was lifted 20% driven by earnings growth and increased payout ratio. CBA also added $1bn to its current $2bn on-market share buyback.
The outlook at this point isn’t looking as rosy as previously expected
The market had been anticipating further meaningful NIM expansion into 2H23 from the lagged effect of RBA cash rate rises in 2022 and further rate rises in 2023. However, CBA indicated that the NIM peaked in October at slightly above the 1H23 average and has stabilised around this level.
While CBA still contends that its low rate deposit base should deliver 4 bps of NIM for each 25 bps cash rate increase over time, intense competition and funding cost increases are a stiff headwind to this benefit. We assume the NIM holds at the Q2 level before declining from 1H24.
Mgmt. commentary pointed to an increasingly cautious outlook on the domestic economy from rate rises and cost of living pressures (albeit CBA has a strong capital position to the point of increasing cash returns to shareholders).
We expect to see costs outpacing productivity savings, slowing credit growth, and reduced asset quality, savings rates, and consumer discretionary spending.
Relatively minimal changes to EPS, with upgrade to net interest income and lower credit impairment charges offset by downgrade to other income. DPS upgraded 10% in FY23F reflecting 1H23A and faster recovery in payout ratio in 2H23F.
Regulatory capital adjusted for impact of new APRA capital adequacy framework.
12 month target price increased (login to view), as a result of forecast changes reflecting the 1H23 result and macroeconomic updates (lower forward rate outlook than previously assumed, risk-free rate reduced to 3.6% pa).
While our valuation has increased and the share price has fallen from recent all-time highs, the stock still does not look cheap on either DCF or historical trading multiple ranges. For income investors, CBA’s current forward cash yield of c.4.4% now looks compressed vs deposit rates.
Furthermore, there is potentially more downside risk if we are at peak earnings and the narrative is cyclically changing away from NIM expansion to cost growth (including normalising credit impairment expense) and risks to asset quality.
CBA remains a core long term portfolio holding, and is the highest quality major bank, but its short term investment performance may be limited.
- 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.
- 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.
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