Sometimes its easy to get caught up in short term moves

Thursday, August 12 2010

I think CBA is a great example at present.

The forecast grossed up yield for CBA for the next two years is around 9% then 10%. This is very attractive relative to cash rates. Furthermore the CBA dividend is 10% above where it was pre GFC. In addition, the company delivers a return on equity currently of 22% and remains a very strong franchise business with dominate market share in most markets it operates in. Growth over the next few years is likely to be driven by improvements in bad debts. Pre bad debt growth is likely to be modest and the market is focused on this at present.

There will likely be some constraints on credit growth rates as consumers de-gear and funding costs are eating into margins. Looking at the growth rate on core components:

Credit growth “mid to high single digit rate” say 6%. Interest margins will be softening leading to modest interest income growth of say 3-4%. However we are tending to form a view CBA is softening the market / community up for an out of cycle rate rise. In their results announcement CBA included slides highlighting how much of their income goes back to Australians. They are talking about the need to balance their funding costs etc. We are looking for a post election rise in mortgages which would be a big driver for the sector.

Other income growth will be focused on non banking activity. The growth rates for Colonial are quite strong (+10%) but other areas could be softer. Total income growth rate around 5% is achievable. Cost growth will be below income growth leading to around 5-6% core growth. Bad debts will be declining from here. For the next two years we could see a further 5% growth pa driven by lower bad debts.

Further enhancement could be made via buy backs or acquisitions. Now the cycle seems to have turned CBA are generating excess capital. They are waiting on regulation being finalized but are flagging the likelihood of buybacks once they have clarity. This could add around 3% pa.

Conclusion: Return is starting at 9% from a dividend perspective. Growth for the next two years should be double digit. Beyond that the growth is more modest as de-gearing occurs (unless buybacks or acquisitions add to the growth profile). The risk will remain the external factors. As has been seen in recent months the banks remain hostage to global sentiment from time to time with the chief concerns remaining funding concerns. CBA™s briefing provided further detail regarding their access to funding markets and outlined their expectation for a covered bond market to be developed over time to reduce the need to tap the European market as aggressively as they have n the past year.



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