Commonwealth Bank: Result 2013

Commonwealth Bank continues to show why it’s our preferred bank, once again producing a record result after shrugging off concerns about low credit growth and a slowing economy.

Revenue increased 6% to $18.2bn, underlying cash profit increased 10% to $7.8bn and earnings per share increased a very respectable 8% to $4.86, giving the company a price-to-earnings ratio of 15.2. A final fully franked dividend of $2.00 (ex date 19 Aug) helped increase the annual total 9% to $3.64, putting Commonwealth on a current yield of 4.9%.

The company’s dividend reinvestment plan remains in place but there’s no discount, and we support the board’s decision to abstain from paying a special dividend. Though it would be a measly amount of money compared to Commonwealth’s $382bn mortgage book, every little bit of financial conservation could help sustain dividends payments as the resources boom and economy slows.

It was an even result, as you can see in Table 2. The heart of Commonwealth’s business, Retail Banking, contributed 39% of total cash profit and increased earnings by 13% to $3.1bn. Commonwealth’s mortgage book increased 6% to $373bn, which was above the market average, and the division’s expenses as a proportion of income fell 1.6% to 38.5%.

The only soft spot in the result was the Business and Private Banking division, which suffered a 2% fall in earnings to $1.5bn due to ‘lower income from deposit products, risk management related products and [strangely] equities trading’.

The Institutional Banking and Markets division and Wealth Management division increased earnings 10% and 9% respectively, as financial markets turned bullish and US interest rates increased dramatically from record lows. Bill Gross, manager of the world’s largest fixed income fund, compared the move to World War I, such was its ferocity and shock as it wiped out years of investment gains for some unfortunate investors who thought buying bonds couldn't be so risky.

Across the Tasman the New Zealand division produced a 17% increase in earnings. Heading west, Bankwest managed to report a 6% increase in earnings despite bad debts almost doubling to $118m. Western Australia is technically in recession.

Surveying other key statistics, net interest margins increased slightly from 2.09% to 2.13%, operating expenses as a percentage of income fell from 46% to 45%, and return on equity fell faintly from 18.6% to 18.4%. In the context of 3% credit growth in Australia it was a top-notch result.

While shareholders should prepare for higher provisions some day, bad debts were flat at $1.1bn and ‘Troublesome and Impaired Assets’ have fallen from $13.9bn in 2010 to $9.5bn. We note 30-days arrears for personal loans and credit cards have increased slightly, but if interest rates stay low and unemployment peaks in 2014 at 5.8% as Commonwealth is forecasting then shareholders should continue to bank decent dividends. Just make sure you’re not overexposed to the banking sector in case a slowing economy provides safer buying opportunities.

Commonwealth has performed admirably since being upgraded in Commonwealth Bank on the buy list on 12 Aug 10 (Long Term Buy – $50.73), but after such a strong run we’re closer to squeezing the sell trigger than upgrading. The share price has increased 10% since Time to sell the banks? from 30 May 13 (Hold – $67.20) and for now we recommend you HOLD provided you’re comfortable with your portfolio allocation.

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.