THE DISTILLERY: CBA strikes

Jotters steer away from politics on Commonwealth Bank's latest figures, while one declares Alesco's 'Billabong moment' has arrived.

Commonwealth Bank of Australia’s $7.1 billion annualised profit is a difficult number to ignore. But it looks like the two sides of the banking profitability debate have bored themselves into submission. Only one columnist, Malcolm Maiden, tackled the issue head on and even then it was somewhat muted by the fact that CBA’s cash earnings grew a modest four per cent.

Thankfully, Australia’s other business commentators have mostly looked at CBA’s results for what they are – the latest set of numbers from the country’s largest banking institution. The question is, will it remain our largest?

But first, the headline profit number. You can tell a heated debate from a more considered, ongoing discussion in the media when respected columnists are forced to retreat to some basic ingredients to bring readers that mightn’t agree with them into the fold.

Enter Fairfax’s Malcolm Maiden, who says there is no disputing two things. Our banks are some of the most profitable in the world and CBA is the most profitable of the big four.

"The Australians have risen to the top of the pile partly because their peers in the UK, Europe and North America sustained massive damage during the global crisis. However, I don't think anyone thinks the country would be better off if they were in strife. Any rational debate about the profits our banks make also needs to take into account what they do. They make bucket-loads of money, but they move tremendously large amounts around the economy in order to do so. CBA, for example, is running a $718 billion asset portfolio: against that benchmark, its $7.1 billion profit equates to a return of just 1 per cent. CBA wouldn't be a business worth owning if that were the end of the story, of course, any more than a milk bar that had been acquired for $1 million cash would be if it earned $10,000 a year.”

What many other commentators touch on this morning, and what The Australian Financial Review’s Andrew Cornell expresses most succinctly, is the generous trading metrics that the market is giving CBA. Can they be maintained?

"Commonwealth Bank trades at a price to earnings ratio about 17 per cent above its major bank peers, with a share price just under 13 times forecast earnings for the year ahead. It’s trading at 2.3 times net tangible assets. The average of its peers is 1.9 times. That premium is due to its track record and specifically the top return on equity number among the banks. For newish chief executive Ian Narev, it’s the best place to be but it’s a tough place to stay and the bank’s June year profit result, while bang in line with what the market was looking for, saw ROE decline more than a whole percentage point, to 18.6 per cent.”

Indeed, The Australian’s Richard Gluyas expands on this issue from the point of view of Narev himself.

"Narev is right when he says a stock should reflect its price as well as value, although it's routine for the market to upgrade or downgrade companies on the basis of little more than relative share prices. The point is that he clearly sees more upside for CBA, and the market is building a picture of how he expects to get it. This has pluses and minuses for CBA, because it means Narev's honeymoon period from his appointment late last year is effectively over."

Business Spectator’s Stephen Bartholomeusz is perhaps the only other journalist that specifically deals with the "are the banks too profitable” debate. Even then it only comes after a lengthy analysis of the bank’s actual results in the context of the broader lending environment.

"The strategy for the major banks has shifted very discernibly from top line and volume-driven growth to introspection and a focus on costs and credit quality. In CBA’s case, operating costs were up 3 per cent but impairment charges down 15 per cent. With funding pressures still acute and no obvious catalysts for a change to the risk-averse stances of consumers and businesses the outlook for the near term, at least, is for more of the same. Despite all the controversies around the major banks’ retention of some of the Reserve Bank’s reductions in official interest rates the funding squeeze on the banks is real, driven by increased wholesale funding costs and the competition for deposits. If the majors are profiteering from their oligopoly, as some politicians keep claiming, they aren’t very good at it. CBA’s net interest margin of 206 basis points in the second half was six basis points lower than in the December half and 11 basis points lower than the same half last year, despite the retentions and some re-pricing of its business lending.”

And from another angle, The Australian Financial Review’s Chanticleer columnist Tony Boyd says CBA’s supremacy in technology, which will pay significant dividends over time, remains intact.

"Any of CBA’s 800,000 shareholders who are worried about the latest evidence of margins being squeezed, revenue slowing and the markets division continuing to perform poorly can rest easy. CBA is years ahead of its big three competitors in technology, which is fast becoming the most important differentiator between companies across all sectors of the economy… At CBA, the relatively new chief executive, Ian Narev, gets technology. He was a left-of-field candidate to replace Ralph Norris last year for good reason. The board wanted someone who could respond to the threats and opportunities posed by technology, including the rapidly shifting customer usage patterns. His right-hand man on technology is chief information officer Michael Harte who admits it took two years to convince the CBA board to back a $1.1 billion core modernisation of CBA’s banking systems. It then took four years to execute this plan. The bank is now showing the benefits of that investment. In the year to June, CBA picked up 38 additional transactional banking clients.”

Boyd has written extensively on this issue and his understanding is superior to almost all banking commentators. When you want a perspective on banking technology, hit up Boyd.

Another respected banking writer, Fairfax’s Eric Johnston, reports comments from Narev that Australian businesses need to get used to the high dollar, even if some industries have little choice but to feel significant pain.

"The Reserve Bank is believed to have taken more decisive steps last week to curb the dollar in response to the currency failing to pull back on declining commodity prices. The focus on the currency came as CBA – the country's biggest bank – confirmed it was also feeling the pressure from slowing demand for housing loans and was being pinched by higher funding costs. While the headline profit for the year to June is the largest earnings result by an Australian company outside the mining sector, its growth in cash earnings over the past year came in at a more sedate 4 per cent while second-half earnings went backwards by 1 per cent. ‘I'm not sure their [the Reserve Bank's] job is to use the ammunition they have to adjust the currency against market pressures,’ he said. But Mr Narev, who took the top job last December, admitted the higher currency was pressuring exporters.”

Speaking of banks, Fairfax’s Michael Pascoe says Maurice Blackburn Lawyers, which is leading the class action against ANZ Bank over penalty fees, is stretching credibility somewhat with its claim that it’s "representing customers”. Pascoe describes MBL as "ambulance chasers”.

The Distillery would love to see a discussion with his fellow Fairfax writer Ian Verrender, who hits a different sentiment this morning: "As more than 170,000 bank customers line up to deliver a right old thumping to our major banks via the nation’s biggest class action over fee gouging, investors are embracing them, deeply attracted by their relative safety and the tantalising allure of hefty dividends.”

Verrender is a card-carrying critic of banking profits in Australia and it should be said that even if MBL are of the ilk that Pascoe suggests, it doesn’t mean the banks don’t deserve to be taken to task over penalty fees.

Still on banking, the Wall Street Journal’s Gillian Tan spots a fact in a report from Bank of America Merrill Lynch that made The Distillery stir. The combined value of Australia’s banks is larger than the Eurozone. Forget the Olympics, we rock!

Meanwhile, The Australian’s John Durie scribbles a few thoughts about CBA’s numbers, but spends more words on Woolworths acquisition of 2812 poker machines overnight.

In other company news, Fairfax’s Insider columnist Ian McIlwraith says the board of garage door maker Alesco Corporation must be resigned to the reality that paints company DuluxGroup will take control. Indeed, The Australian Financial Review’s Matthew Stevens writes that Alesco has reached its "Billabong moment”.

Fairfax’s Elizabeth Knight makes the good observation that Echo Entertainment is receiving shelter from investor disappointment. The company can afford to put out results that fall short of expectations and the shadow of billionaire James Packer, who wants to seize control of the company, keeps the stock price up.

Packer’s aim is to take Echo without paying a takeover premium. Speculators must surely be aware of this and are still willing to take the chance.

Fairfax’s Adele Ferguson says yesterday’s Westfield results show that the decision by the Lowy family to split the company in two is being vindicated.

In economic news, Fairfax’s Tim Colebatch flips through a report from global consultant McKinsey that casts a shadow over the Australian economy because the forces that have brought about the mining boom will reverse at some stage. The Australian’s economics correspondent Adam Creighton focuses on the same report, examining the conclusion that Australia’s productivity collapse.

And finally, frustrated by a still as-yet-to-be-released white paper on Australia in the Asian Century, The Australian’s Asia Pacific editor Rowan Callick turns his attention to Taiwan, our sixth largest export market.

The story is inspired by comments from Business Council of Australia president Tony Shepherd, who claims that Australia companies are embarrassed to report big profits, especially the banks.

By contrast, Shepherd claims that American companies far from being embarrassed by their record profit results are proud of them. He goes further to suggest that such profits are celebrated in the land of the free.

True, they aren’t embarrassed by their results, but the idea that they’re celebrated over there is absolute bollocks.

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