To our eyes, CBA's FY23 Result this week gave clues about the building return dilemma that the CBA Board could face over the FY24-26E period.
The clues were contained in the 2H23 dividend of $2.40, which came in above market at the top end of consensus and took the dividend to the top end of the target payout range of 60-80%. The first time since COVID-19.
Under an Australian economic soft-landing scenario where bad debts remain well contained, normalising to levels well below prior cycles, CBA could be generating 0.5%-1.0% of surplus capital per year across FY24E, FY25E, FY26E or $2.5-$3.5bn per year. CBA generated 0.7% of organic capital in 2H23.
With CBA CET1 capital already sitting well above APRA minimums at 12.2% (proforma for 2H DPS), CBA could have a returns dilemma on its hands.
The inability to distribute surplus capital back via fully franked off-market buybacks compounds the issue. CBA’s franking credit balance is likely to grow, even if the Board continues with ordinary dividends coming in at the top end of the 60-80% dividend payout range.
Special dividends become a live option, notwithstanding the greater utility of buybacks in terms for CBA’s management KPIs (which link back to DPS).
One of the differentiating features of CBA’s capital management over the last two decades has been the Bank’s ability to manage its shares on issue materially better than any of its peers. Since 2000, the CBA share count has grown by ~30%, vs peers who have on average have grown share capital by >100%.
This continues today, where ANZ Group (ANZ) is negotiating with regulators to buy Suncorp’s (SUN) retail bank for 1.3x book, having raised ~$3.5bn at 0.95x book value in 2023.
Bottomline, we see the prospect that capital management could feature across FY24-26E under a resilient Australian economy and benign outlook of bad debts. A combination of both on market share buybacks and special dividends could add another ~1% pa to CBA’s current dividend yield of 4.2% FY24E.
Investment View
FY23 results are a show of resilience, backed by a better-than-expected dividend outcome. We expect little change to FY24E market earnings estimates.
The FY23 Results adds to the relative defensive appeal of CBA, where its market position and strong execution continue to position CBA as a dependable performer.
CBA is not cheap, but the prospects of a more benign Australian economic outcome across FY24, opens the door to ongoing capital management (+$2bn pa, implying a ~2% reduction in shares on issue). Something which is not currently factored into market estimates.
Risks to Investment View
Upside risks relate to stronger than expected cost control, mortgage repricing, and further market share gains. Additional capital management initiatives would also be well received.
Key downside risks include further deterioration in interest margins, lending competition intensifying, and a material slowdown in credit growth.
A significant and rapid fall in house prices would present a risk to the share price. CBA’s current premium valuation presents a risk if CBA were to show a slowing of its earnings growth and market share gains, or if peer banks displayed stronger operational performance.
Recommendation
We have retained our Hold recommendation.
Figure 1: CBA return framework. Reinvest 20-30% of earnings, return 60-80% via dividends or capital buybacks.
Figure 2: Sandstone Insights major bank surplus capital scenario assuming only a very modest pick in bad debts into September 2023.
Figure 3: Consensus CBA payout ratio at the top end of the target range. 2H23 payout ratio lifted to 80%.
Figure 4: CBA dividend yield of 4.2% remains below peers. Consensus has flat ordinary DPS growth estimated for FY24E.
Figure 5: Major bank comps table.
Figure 6: CBA premium valuation remains. Reflecting the strength of the franchise and its well rated management team.
Figure 7: CBA PER rel to ASX200 implies some further small share price upside is possible under a soft-landing scenario.
Figure 8: Despite CBA premium to book value, CBA has largely resisted the temptation to use its lower cost of capital to fund acquisitions.
