Commonwealth Bank (ASX:CBA) Stock Analysis - April 2015

Commonwealth Bank of Australia (ASX:CBA) is one of the largest Big 4 banks in Australia. It is one of the most recognised brands in Australia. It is highly profitable, with operation in Australia and New Zealand and Asia. Commonwealth bank's services include:
  • Full suite of banking services
  • Insurance (General and life)
  • Wealth management
Australian banks, which includes CBA, were among the few banks in the world that came unscathed from the global financial crisis (GFC).

Competition
Banking industry in Australia is a classic case of oligopoly. An oligopoly is a market structure in which a few firms dominate. Australian banking industry is dominated by the Big 4 banks - CBA, NAB, ANZ and Westpac. Together, the Big 4 banks control more than 90% of the regulated market. As a result, Big4 banks together make it difficult for new players to gain any market share. Big 4 banks also hold cost advantages over their small competitors due to massive economy of scales.

Neither local regional banks (which tend to follow Big4 trends) and nor foreign banks are in a position to pose any meaningful threat to the CBA's dominant position in the foreseeable future.

CBA is leading the modernisation of the banking system in Australia with its CBM program. This is evident from the sleek, modern and exceptional retail banking website and phone apps. This investment in technology should help CBA gain competitive advantage among the Big 4 banks.

Revenue
The following graph outlines the revenue growth of CBA in the last 10 years.
As can be seen from the graph above, revenue has grown by 43% in the last ten years from AUD 17.9 billion to AUD 26.3 billion in 2014. CBA recorded slow growth in revenue with 3 year, 5 year and 9 year growth rate (CAGR) at 6%, 8% and 4% respectively. Even during the GFC in 2009, the worst thing that happened was that the revenue fell by mere 10%, although revenue per share fell by 15% as a result of share dilution. The effect of share dilution is also visible in the revenue per share growth rate, with 3 year, 5 year and 9 year revenue per share growth rate coming in at 4%, 6% and 1% respectively.

Earnings
In order to arrive at the owner's earnings, the cash based 'R&D' expenses and non-cash 'Depreciation, Depletion and Amortisation' expenses have been added to the reported Net Income.

The graph below shows the reported earnings, owners earnings and cashflow in the last 10 years.
In the last ten years, the owner's earnings have doubled from AUD 4.46 billion to AUD 9.3 billion in the year 2014. CBA recorded moderate growth in earnings with 3 year, 5 year and 9 year growth rate (CAGR) at 10%, 12% and 8% respectively. Remarkably, during the GFC (2008-2009) CBA's owner's earnings increased from AUD 4.7 billion to AUD 5.1 billion as is evident in the graph. While the overall earnings during GFC increased substantially, EPS (earnings per share) only increased marginally due to share dilution. The effect of share dilution is also visible in the earnings per share growth rate, with 3 year, 5 year and 9 year eps growth rate coming in at 7%, 10% and 5% respectively.

At the time of this writing, Australia is going through soft credit growth, which may have an impact on the short term earnings growth.

Australia's superannuation industry is one of the fastest growing industry in wealth management, with compulsory super contribution to rise to 12% by the year 2022. This should provide some consistent earnings growth and a cushion to soft credit conditions.

Expense vs Income
In the last 10 years, CBA has spent an average of 12.5% of its owners earnings on 'R&D', 'Property, Plant and Equipment' and 'Purchase of business'.

The graph below outlines the 'Earnings vs Expense' ratio in the last 10 years.
During the last 10 years, CBA spent a sum total of AUD 2.9 billion on acquisitions, which comes to mere 4.5% of total owners earnings during the same period.

This demonstrates that the management team has been quite prudent at making acquisitions, instead of going on a buying frenzy to raise revenue they have been quite focused on making good deals. One such example is CBA's acquisition of BankWest in 2008. CBA acquired BankWest in 2008 from Bank of Scotland in the midst of GFC at rock bottom prices.

Bad Debt
The graph below outlines the 'Credit loss provisions' in the last 10 years.
Global financial crisis exposed the bad debts made during the boom year. The credit loss provision increase nearly three fold from AUD 930 million to AUD 3 billion in 2009. It has since been declining at a steady state, which is a positive development.

PE ratio
The graph below shows the PE ratio trend in the last 10 years.
Since the GFC, CBA ratio (based on owner's earning) has ranged from a low of 12 to a high of 14.6. CBA PE ratio (based on reported earnings) has ranged from a low of 11.33 to a high of 15.97.

Return on Equity 
The graph below outlines the ROE trend in the last 10 years.
As can be seen, the ROE has been quite stable except the GFC and has ranged between 18% to 20%.

Dividend
The graph below outlines the dividend per share trend in the last 10 years.
In the last 10 years, the dividends have increase at an average of 7.57% and at a CAGR of 8.16%.
A CAGR of 8.16 implies, dividends doubling every 9 years.

The current dividend payout ratio sits at an uncomfortable 106%.

Yield
The graph below outlines the buyback, shareholder and dividend yield trend in the last 10 years.
In the last 10 years, the dividends have increase at a fantastic CAGR of 8.16%. CBA has returned a total of AUD 32 billion to its shareholder through dividends. Currently, CBA has a dividend yield of 6.29%. I expect that in future, the dividends are more likely to grow at a CAGR of 4-6% due to very high dividend payout ratio of 106%.

On the other hand though, CBA has added a total of 392 million additional shares. This in turn, has resulted share dilution of massive 31% over last ten years. Taking the effect of share dilution into consideration, CBA has returned a total of AUD 26.15 billion to its shareholders.

In total, CBA has been able to return 41% of its total owner's earnings to shareholders through dividends and share dilution.

Risks
Several economists believe that house prices in Australia (especially in Melbourne and Sydney) are over-valued by upto 30 percent. Concerns about a market bubble and subsequent crash have often been made. Only recently, Glenn Stevens, governor of RBA, made a remark that Sydney house prices "look rather exuberant". Some of the commonly cited reasons behind heated property markets are:
  • Foreign buyers (China)
  • Negative gearing
  • Rise of SMSFs borrowing to invest in Super
  • Low interest rates
Some fear that in case of a housing market correction, Australian banks may suffer the similar (horrible) consequences as the banks in America did during sub-prime mortgage crisis. While it is true that Australian housing market is expensive and affordability is an issue, Australian banks are in a much better position to handle a correction due to:
  • Strict underwriting standards
  • Lender's mortgage insurance for loans for 80% LVR
  • Full recourse lending
  • High proportion of variable rate home loans
  • Possibility of rate cuts by RBA
Future
Slowdown of the mining and commodity sector combined with weakened employment market may impact the revenue.

In addition, since banking is highly regulated industry, adverse regulatory changes, however unlikely, is always a threat.

Valuation
The current market cap for CBA (ASX:CBA) stands at AUD 149.9 billion at a trailing PE (reported earning) of 17.50 and at a fwd PE of 15.63. At current share price ($92.1), it offers a trailing dividend yield of 6.45%.

Full Disclaimer: I am not a financial planner. The views expressed in this post are all mine and they may or may not suit your needs. Please do you own due diligence. I do not make money on any of the products suggested in this post.

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