CBA: Interim result 2014

Commonwealth Bank might be the world’s most expensive bank, but its interim result shows why. Despite slow credit growth, operating income increased 8% to $11.1bn, helping increase cash net profit 14% to $4.3bn. Earnings per share increased 13% to $2.64, and a fully franked dividend of $1.83 was declared, up 12% (ex date 17 Feb), for a forecast dividend yield of 5.2%.

At 18.7% return on equity is not that far away from the record 21.7% achieved in 2007 prior to the GFC, which is remarkable given the poor performance of most other banks around the world and the regulated increases in capital and liquidity ratios.

Steadily increasing revenue, falling borrowing costs, cost cutting and falling (provisions for) bad debts have been an elixir for slower credit growth. As you can see in Table 2, there were strong performances across the board in the recent half with Commonwealth ticking off just about every performance measure imaginable. Competition for deposits is still strong, though, which contributed to a minor three basis point fall in the net interest margin to 2.14% compared to the previous half.

Outlook

Chief executive Ian Narev said ‘We remain cautiously optimistic about the economic environment for this year. We have seen, in recent weeks, that there is still volatility in global markets. The risks presented by that volatility continue to suppress business confidence. As a result, there is little real evidence, so far, of a meaningful increase in investment in the rest of the non-resource sector of the Australian economy, other than in housing.’

We don’t expect a lower Aussie dollar to offset slower growth in the resources industry, particularly as consumer debt levels remain high and many companies struggling with the strong Aussie dollar have already shut down or are planning to. As the resources investment boom ends, highly paid staff from companies like the bankrupt Forge are also unlikely to find similar paying jobs.

That means credit growth could remain slow for many years and that shareholder returns from the banks will be increasingly weighted toward dividends rather than capital gains. For income investors with modest expectations that should work out fine provided the company can navigate any larger macroeconomic issues, such as slowing growth in China or falling home prices.

As Australia’s best bank we’ve given Commonwealth plenty of leeway in the recommendation guide even though it looks expensive on most historical measures. If Commonwealth has become a large part of your portfolio, though, now is a good time to consider taking some chips off the table.

Commonwealth has performed admirably since being upgraded in Commonwealth Bank on the buy list on 12 Aug 10 (Long Term Buy – $50.73), and with the share price falling 3% since Commonwealth Bank: AGM 2013 from 11 Nov 13 (Hold – $77.90) we’re sticking with HOLD.

Note: The model Income Portfolio owns shares in Commonwealth Bank. The maximum recommended portfolio limit for the banking sector is 20%, though conservative investors might consider a limit of less than 10% at current valuations, particularly if you have other large exposures to residential property.