Australia’s Largest Bank CBA Bares All To See

Australia’s largest bank, the Commonwealth Bank of Australia (CBA), has recently unveiled its comprehensive full-year 2023 reports. While mainstream news might be buzzing with updates on the state of the economy. I hold the personal conviction that delving into the ASX-listed companies can offer us a more nuanced and insightful perspective.

To grasp a finer understanding of factors like food inflation, giants like Coles and Woolies provide a segmented breakdown of inflation and deflation. Similarly, for a glimpse into the dynamics of building and construction materials, one can turn to the insights shared by Brickworks or Goodman Group. You catch my drift.

Bank annual reports offers a splendid opportunity to gain insights into the economic landscape and consumer spending trends. As Australia’s largest bank leads the charge this earnings season, we stand to glean valuable insights into the broader Australian economy.

Now, let’s not be coy about my stance on bank stocks in the Australian context. The four banking behemoths, spearheaded by CBA, together shape an oligopoly. However, when it comes to creating substantial value for shareholders, this quartet has somewhat faltered. As an investment avenue, they don’t quite earn a top spot on my list of preferences.

Yet, the financial sector remains one of the most prevalent components in Australian investment portfolios. This shouldn’t come as a surprise, considering that the ASX300 composite bears a significant weightage attributed to the banking giants.

Even if you do not hold these stocks personally, chances are your superannuation fund holds them on your behalf. Hence, cultivating an interest in their affairs could be a rather judicious move.

As we delve into the revelations of CBA’s 2023 full-year report, let’s embark on a journey to decipher not only its impact on the economy but also the intricacies of its business operations.

Our Largest Bank And Our Economy

It’s common knowledge that Australians and our global peers are grappling with surging inflation. This translates to elevated living costs and restrained spending due to loan repayments.

Yet, the impact of escalating interest rates isn’t uniform or even applicable to everyone. Interest rate, in essence, signifies the expense of capital, i.e., the price of borrowing money.

So, if you’re managing any forms of loans, these might have a more noticeable effect on you. Folks devoid of such financial obligations are less likely to feel the pinch as profoundly. According to CBA’s assessment, the brunt of elevated rates affects various households differently within a challenging environment.

Consumption and Savings

CBA’s presentation illustrates that those aged under 45 face more pronounced pressures, primarily due to higher mortgage burdens. They also tend to hold fewer deposits and may have to tap into their savings.

Conversely, older Australians find themselves in a more favorable scenario. With healthier deposit balances and adjustments in savings strategies, the senior generations are reaping higher interest-related income. Moreover, they’re the ones observing an uptick in consumption trends.

Arrears and Provisions

CBA is foreseeing a bump in future arrears and ha increased their provisioning by 1.64%. This brings their recognized provisions to a hefty $5.95 billion, with a potential downside scenario of $7.9 billion.

Predicting macroeconomic shifts is no easy feat, and unfortunately, the largest banks’ report doesn’t bring much cause for celebration.

CBA Performance

Among Australia’s top four banks, CBA has outshone its counterparts, and that’s certainly no minor achievement. Yet, holding the top position in the Australian banking arena doesn’t grant immunity from subpar performance.

Bear in mind, the banking industry is entrenched in cutthroat competition, whether you’re willing to acknowledge it or not. It’s akin to a commodity business, with the said commodity being money.

Given this commodity nature, there’s a limit to what you can charge. Essentially, what you’re peddling is identical to what your neighbor is offering. This reality translates to razor-thin margins to stay competitive.

Since 2015, amid record-low interest rates and a property boom, CBA has witnessed earnings remaining relatively steady. At times, even declining prior to the pandemic. While it’s not solely CBA’s responsibility, other banks also missed the chance to capitalize on Australia’s property surge.

Dividends per share have maintained a rather stagnant trajectory, even experiencing decreases over the past decade. With the arrival of higher interest rates in 2023, banks are likely to see a marginal uptick in their net interest margins. Which has translated into a notable earnings surge this year.

When we assess CBA as a business, it’s clear that its performance in terms of both earnings growth and dividend growth has been somewhat lackluster. Furthermore, the share price has only advanced by 21% since 2015. It’s fair to assert that investing in CBA during this period has trailed behind the Australian stock market’s performance, dividends included.

CBA’s potential for robust growth from this point onward can’t be discounted entirely. My optimism regarding results surpassing the market’s performance remains tempered.

Valuing Australia’s Biggest Bank

Valuing banks poses a challenge when using a discounted cash flow model, mainly because their entire financial structure hinges on borrowed funds. Essentially, their assets are composed of borrowed money sourced from depositors or international money markets.

Australian banks aren’t akin to high-growth companies with staggering 50% annual revenue or earnings escalations. Neither do they thrive in growth-driven markets.

Their growth potential is more restrained, likely revolving around single mid to low-digit rates. These growth figures are typically influenced by modest inflation rates and population expansion.

Precision in valuation is paramount for businesses that exhibit slow growth rates. It takes fewer missteps for investments to falter. When considering bank stocks, a wiser approach involves examining their PE ratio and book value. This pragmatic strategy can offer more insight into their worth.

A more insightful lens to view the P/E ratio is through the earnings yield—simply reversing the P/E value. In CBA’s context, a P/E of 17.26 translates to an earnings return of 5.7% (1/17.26).

When dealing with a business poised for low to single mid-digit growth, a 5.7% earnings yield appears less appealing. Especially considering that CBA’s peers are trading at significantly lower P/E multiples.

Additionally, CBA’s price-to-book ratio stands at 2.43. This implies you’re shelling out over twice the value for Commonwealth Bank’s assets. While this might align with the needs of high-growth companies, it might not be a prudent choice when you consider that banks carry substantial debt on their balance sheets. Overpaying might not pan out as a wise investment move.

Moreover, CBA’s loan book is significantly focused on consumer lending. Within their balance sheet, nearly 70% is tied up in home loans, accounting for a substantial $652 billion out of the total group lending of $930.8 billion. Remarkably, a mere 12% of loans going sour could spell trouble for CBA.

Given the trajectory of rising interest rates and homeowners grappling with financial strain, being in such a position isn’t the optimal stance for me as an investor.

While being the largest bank in Australia might warrant a loftier valuation, I find CBA to be slightly overpriced. This sentiment is even more pronounced if one intends to outpace the market; CBA might not be the top performer in that regard.

Key Takeaways

• Escalating interest rates impact borrowers differently, while older Australians benefit from deposits and higher interest-related income.
• Australian banks lack high-growth trajectories. Precision in valuation is vital for slow growth businesses; examine P/E ratio and book value.
• CBA’s consumer-focused loan book raises concern amid rising rates.

Incognito Wealth – Investing Tools

Need help with investing in the stock market or personal finance? Visit my Etsy store for digital excel templates. Simplifying finance so that everybody can reach financial independence.

Incognito Wealth - Financial Independence One Investment at a Time