Less Than Perfect CBA Threatens Its Premium

This story features COMMONWEALTH BANK OF AUSTRALIA, and other companies.
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A sharp sell-off in CommBank shares post a relatively benign first quarter update has yet again put the focus on that large valuation premium. Is the competition catching up?

• CommBank’s Q1 update disappointed on net interest margin, costs
• Given sizeable valuation premium, some view this as 'simply not good enough'
• Ord Minnett believes CBA is the most expensive bank ever in developed markets
• Is a large relative premium sustainable if/when peers achieve better operational momentum?

By Greg Peel

Stockbroker Morgans sums it up nicely: as well as being Australia’s largest bank, compared to its peers Commonwealth Bank ((CBA)) has the highest return on equity, lowest cost of capital, leading technology, largest position in the residential mortgage market (with the lowest risk portfolio in this low risk market segment) and largest low cost deposit base (with a greater skew to households and transaction accounts than its peers), plus a loyal retail investor and customer base.

Why then do all six brokers monitored daily by FNArena covering the bank have Sell or equivalent ratings on the stock?

A clue likely lays in their consensus target price. An average of $117.81 is around -25.60% below yesterday’s closing share price of $158.38.

Mind you, this is after a near -9.50% shellacking of the share price post quarterly market update, while price targets have hardly moved in the aftermath.

Only one of the six brokers adjusted its target post CBA’s first quarter update: Morgans cut to $96.07 from $100.85. That’s -39.34% below the current price. The high-marker on target is Morgan Stanley with $144.80. That’s a big gap to Morgans’, but still -8.75% below.

The reality is CBA has drawn a full suite of Sell ratings for about as long as anyone can now remember. Yet the share price has risen 118% over the past five years. Broker targets have been ticked up over that period, but the overwhelming view from analysts has long been “priced to perfection”.

Thus when analysts saw a sharp sell-off in the stock in response to the first quarter update, the initial thought was one of “overreaction”. Until one takes “priced for perfection” into account.

The bottom line is CBA is a must-own in any market portfolio (or even global portfolio), vying as it does with BHP Group ((BHP)) to be Australia’s largest listed company. (Currently, that contest has been decisively won, but nothing is ever set in stone indefinitely).

This ensures a reliable safety net under the share price, but this week’s sell-off provides a warning to investors: CBA is not bullet-proof.

As Ord Minnett notes, current twelve-month consensus forward earnings (PE) multiple remains above 27x (now 25x post sell-off, on FNArena’s consensus), which keeps CBA as the most expensive bank ever in developed markets.

“There will be only one way to go when the cycle turns.”

Earnings Meet Consensus

CBA’s revenue grew 3% in the quarter and both net interest income and “other” income grew 3%, in line with consensus.

Pre-provision operating profit was actually better than expected. But the result showed more pressure on the bank’s net interest margin (NIM) than the market expected, and surprisingly high growth in costs.

That’s what spooked the market.

The bank blamed customer switching in the search for higher deposit rates, the falling interest rate environment, and ongoing fierce competition in the home loan market for the squeeze on margins, while wages inflation and increases in IT vendor spending were cited for the disappointing cost outcome.

CBA’s NIM contracted -5 basis points quarter-on-quarter to 2.03%. Removing the -3bp impact of strong growth in liquids and its repurchase agreement (repos) activity, which will wash out without really affecting returns, Ord Minnett fears the remaining -2bp of contraction may be a longer-lasting impact rather than just a short-term blip.

Costs increased 5% including notable items, such as an -NZ$136m charge related to the class action lawsuit against its ASB business in New Zealand, while underlying costs rose 4%, driven by the above-mentioned wages inflation and IT vendor expenses.

Brokers were all drawn to management’s commentary that IT vendor costs were actually “seasonally lower” in the quarter, which suggests cost growth, at least that related to IT, could pick up pace from here.

The last three years’ experience suggests cost growth accelerates through the year, and Citi is estimating circa 5.4% cost growth for FY26 (ex one-offs).

Asset quality erosion at CBA remains benign, with non-performing loans as a proportion of total committed exposure actually falling to 0.45% from 0.97% in the prior quarter, while its capital position remains robust with a common equity tier-one (CET1) ratio of 11.8%.

Relatively Speaking

At first blush, Citi suggests CBA’s in-line September quarter cash profit of $2.6bn looks “odd” versus the stock selling off sharply on the print. However, Citi also believes the generally unremarkable earnings update is potentially the issue relative to peers.

Revenue growth of 3% in the quarter was in line with consensus, but not dissimilar to peers (Westpac ((WBC)) achieved 4%). Credit growth is solid, but the associated NIM attrition (competition, deposit mix) is a sector story. Asset quality and capital remain fine, but aren’t differentiated versus peers.

Historically, CBA has tended to de-rate if peers exhibit better earnings momentum or as market breadth improves. Given recent positive earnings revisions from ANZ Bank ((ANZ)) and Westpac, following FY26 results, and a lack of differentiation in CBA’s numbers, Citi thinks the valuation premium will increasingly come under pressure.

Macquarie notes despite generally better margin commentary from peers, CBA flagged a more challenging margin outlook, highlighting headwinds from deposit mix (as customers switch from low-rate online savers to higher-rate bonus savers), continued competition, and the impact of rate cuts.

Quarterly results have historically been unpredictable, UBS notes, making it challenging to form a definitive view on this release due to limited information. However, the headline figures indicate CBA is delivering results broadly in line with expectations for the first half FY26, as reflected in consensus estimates.

The increase in costs is somewhat surprising, UBS suggests, even excluding notable items, as is the decline in the CET1 ratio to 11.75%, compared to the first half consensus estimate of 12.3%. Further credit RWA (risk-weighted asset) optimisation at CBA appears limited relative to peers, given the substantial progress already made by the bank.

UBS believes these results could impact the stock’s performance. Over the past month, CBA’s share price had risen 3.91% (to November 11), outperforming National Bank ((NAB)) and Westpac but lagging ANZ, which gained 8.95%.

“Given the current valuation, it would appear perfection is implicitly expected.”

In comparing the Big Four post this month’s earnings results, Jarden (not monitored daily) suggests ANZ has the clearest, most numerate plan, but new CEO Nuno Matos must now execute and deliver.

Westpac has the best momentum in its operating franchise, but must not stall as it moves into the heavy lifting of its UNITE platform implementation.

For NAB, Jarden sees lots of talk but little action, and believes NAB has lost its clear market leadership in business banking for which CBA and Westpac have superior growth, return and customer experience metrics.

For CBA, Jarden sees “business as usual”.

Given CBA’s valuation premium, is “business as usual” enough?

The Same Song Sheet

While CBA remains the leading banking franchise in Australia, with cracks appearing in its deposit “moat” and further downside risk to consensus, Macquarie believes valuation of circa 26x FY26 PE (FNArena: 25x) and 3.5x price-to-book value remains detached from fundamentals.

UBS also highlights CBA’s price-to-book is significantly higher than its historical average. FY28 consensus earnings are around 26.9x the bank’s current price alongside a dividend yield of circa 2.94%. UBS sees better value elsewhere in its coverage universe.

CBA has a number of structural advantages versus peers, but Citi thinks the valuation premium will continue to come under pressure while trends are in-line and earnings revisions momentum is stronger at peers.

Share price performance has not been as strong as it was ahead of the FY25 result, but Morgan Stanley sees little reason why CBA should outperform the other majors.

Morgans believes potential medium-term returns are too compressed at current prices considering CBA’s earnings and dividend outlook and elevated trading multiples. This broker recommends clients “aggressively reduce” overweight positions given the risk of poor future investment returns arising from the even-now overvalued share price and low-to-mid single digit earnings and dividend growth outlook.

Ord Minnett maintains its negative view on the banking sector in general as valuations remain at elevated levels that this broker does not see as reflective of industry fundamentals. As noted, Ord Minnett points out CBA is the most expensive bank ever in developed markets and “there will be only one way to go when the cycle turns”.

Jarden also has a Sell rating on CBA, with a $100 target.

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