Commonwealth Bank: Premium relative to peers remains unjustifiably large

About the author:

Azib Khan
Author name:
By Azib Khan
Job title:
Former Senior Analyst
Date posted:
18 November 2021, 9:30 AM
Sectors Covered:

  • Commonwealth Bank's (ASX:CBA) 1Q22 unaudited cash NPAT is ~9% lower than our expectation largely due to the net interest margin (NIM) being significantly lower than our expectation, non-interest income softness and higher-than-expected operating expenses.
  • Our view is that CBA’s stock has been trading on a significant premium relative to peers, and we believe this premium remains significant despite CBA’s share price fall in the last trading session. In our view, the 1Q22 trading update emphasises that the current extent of the premium is unjustified.
  • While WBC has also experienced significant NIM contraction, our view is that WBC’s stock has been far from being priced for perfection. We also believe that the NIM headwind from Australian home lending competition coming through for CBA is greater than that coming through for WBC. Furthermore, the cost outlook for WBC is more attractive than that for CBA in our view. For these reasons, we believe the extent of CBA’s P/NTA premium over WBC – currently ~85% – is very difficult to justify, particularly bearing in mind that these two major banks have similar loan book compositions and a similar return on tangible equity (ROTE).
  • We have downgraded our cash EPS forecasts for CBA by 9-11%. Retain Reduce recommendation.

Significant NIM contraction the lowlight of the 1Q22 trading update

We calculate that the Group net interest margin (NIM) contracted by 14bps from 2.04% in 2H21 to 1.90% in 1Q22. Excluding liquid assets, we calculate that the NIM contracted by 7bps over the same period.

Excluding liquids, we infer that the NIM contraction was driven predominantly by home lending competition and mix. It appears to us that this headwind is stronger for CBA compared with WBC.

We particularly think this is the case as CBA has said that domestic business lending continued to grow above system in the quarter on stable margins, whereas WBC’s group margin contraction was also attributable to contraction in business lending spreads.

The increase in liquid asset balances in the Sep-21 quarter is unrelated to the RBA’s Committed Liquid Facility (CLF) and appears to be the result of a transient surplus funding position stemming from Term Funding Facility (TFF) drawdowns and customer deposit growth.

We expect some reduction in CBA’s liquid asset balances in the Dec-21 quarter as the surplus funding is used to replace maturing term wholesale funding. Despite our view that liquid assets are likely to reduce in the Dec-21 quarter, we expect further headline margin contraction from 1Q22 to 2Q22.

Adding headcount to process lower margin volumes?

Excluding remediation costs, CBA’s operating expenses increased 3% on a runrate basis from 2H21 to 1Q22. CBA has said that this was mainly due to higher staff costs from lower annual leave usage, and increased staffing levels in response to higher volumes and to help deliver on strategic priorities.

It appears that the intensity of home lending competition is now at the point that not only is it resulting in significant margin contraction, but it is also resulting in increased staffing levels to process lower margin volumes. 

We believe that we are now seeing the peak intensity of home loan competition and we do not expect further intensification from here.

Credit quality sound

CBA has disclosed a credit impairment charge of $103m for 1Q22, equating to an annualised 5bps of average gross loans and acceptances. Following provision releases in 2H21, total credit provisions were broadly unchanged over 1Q22.

CBA has said that its current level of credit loss provisioning reflects both sound portfolio credit quality and a cautious approach to provisioning as the economy recovers from restrictions related to COVID-19.

Investment view and changes to forecasts

We have reduced our cash EPS forecasts by 10.7%/9.4%/9.2% for FY22F/FY23F/FY24F respectively largely due to lower net interest income, lower non-interest income and higher operating expenses.

Our target price, based on our DDM valuation, is reduced to (login to view).

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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