Why this fundie isn't topping up on CBA off the back of its result

The Commonwealth Bank's share price is storming higher today after it reported its cash profits lifted by nearly a quarter in the first half to $4.7 billion, with Australia's biggest bank announcing a fully franked dividend per share of $1.75, up 17% from the previous first half, on the back of the result.  

Over the 12 months to December, CBA reported an 8.5% growth in home lending, a 12.2% increase in household deposits, a 12.5% lift in business lending and a 14.1% rise in business deposits. Meantime, its loan impairment expense decreased $975 million to a benefit of $75 million, buoyed by Australia's improved economic outlook. 

CBA also announced it would undertake a $2 billion on-market share buy-back. This follows the completion of a successful $6 billion off-market buy-back during the half. 

And yet, unlike the investors propping up the banks share price today, Plato Investment Management's Peter Gardner says CBA is not a buy, with the bank still trading at a 40% premium to its peers. 

In this wire, Gardner takes you through the nitty-gritty of Australia's second-largest company's half-year result, as well as the financially-focused companies he prefers for his portfolio over the months ahead. 

CBA KEY RESULTS 1H22

• Statutory NPAT: $4.741 billion, up 26% from 1H21
• Cash NPAT: $4.746 billion, up 23% from 1H21
• Operating performance: $6.617 billion, up 4% from 1H21
• EPS: $2.73, up 54 cents from 1H21
• Dividend per share: $1.75, up 25 cents from 1H21

Note: This interview took place on Wednesday 9th February 2022. 

What were the key takeaways from the result?

Peter Gardner: It was a good result from the Commonwealth Bank. Its profit was up 23%, which is about 4% above market expectations. And that's largely been demonstrated by the market's reaction today.

CBA is outperforming the other banks by around 3-4%. Its dividend was up 17%, which was a 2.7% gross yield for this dividend or almost a 6% annual gross yield. CBA's payout ratio was just 64%, so it is still conservative in that regard. And it also announced a $2 billion on-market buyback. 

CBA also completed a $6 billion off-market buyback last year, and so it is continuing to return some of that cash back to shareholders, reducing CBA's CET1 ratio down to 11.8%, a reduction of 1.3% from August. It's still well above the 10.5% it needs to be at for APRA, but that means CBA is improving its earnings per share because it is reducing its share count. 

The standout of the result was definitely CBA's costs; which it was able to contain to modest levels while continuing its above system lending growth. 

CBA's home lending grew at 8.5%, which was 1.2 times the system and its business lending grew at 12.5%, 1.7 times the system, while only increasing its costs by 2%. 

Its net interest margin fell in line with the other banks, reducing by nine basis points to 2%. That was the poorer part of its result, but that's similar to the other banks and the market was expecting that.

What was the market’s reaction? Do you think this was an overreaction, underreaction, or appropriate?

I think the market's reaction was appropriate given the strength of the result, as CBA generated earnings about 4% above market expectations.

I think investors should be aware that banks are actually an area of the market that could benefit from interest rate rises. In the context of interest rates rising, we think the property market is going to stay flat or even fall, depending of course on how much the RBA does increase interest rates. 

So the kind of lending growth that we have seen from CBA is unlikely to be sustainable in that context, but in terms of how it has been performing versus the market, we think that is sustainable.

CBA can continue to outgrow the market given its strong brand, franchise and technology. It is able to process home loan applications quicker than some of its peers, which enables CBA to win more customers. 

Were there any major surprises in the result that you think investors should be aware of?

The $2 billion on-market buyback was a surprise. We had forecast another buyback from CBA in the second half of this year. So it was a bit of a surprise for them to do it so soon after its last buyback. So in terms of timing, yes, that was a surprise. But CBA definitely has room, given where its CET1 ratio is, to potentially do another $2 billion top-up in the second half of this year as well.

In terms of impending interest rate rises, CBA did mention that every 25 basis point hike in the cash rate would improve its net interest margin by four basis points. 

And that's because of those deposits that it has. In fact, 73% of its funding comes from deposits at the moment, which is incredibly strong. And that is a lot higher than it used to be before the GFC when it was around 55%.

A reasonable number of these deposits are paying a 0% interest rate, and so any increase in the RBA cash rate doesn't increase those deposits at all. And yet, CBA is able to increase its lending at that rate.

Would you buy, hold, or sell CBA following this result?

We think it's a hold. CBA is currently trading at a 40% premium to the other banks, but we think the strength of this result warrants that premium and we don't see that dropping anytime soon. 

CBA has the best technology, the best innovation, it's growing at a stronger rate, and it has the best return on equity. It's definitely the strongest bank franchise and that is why it's trading at that 40% premium. But as investors, we need to decide when these factors are priced in and we think it's fairly appropriately priced at the moment.

If CBA was to underperform the other banks by 5% or 10% from where it is trading currently, then that's definitely where we'd be looking at moving them to a buy.

What are your expectations and outlook for CBA and the banking/financial sector?

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