Commonwealth Bank is a good fit for SMSFs

Co-founder of the Switzer Report
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Commonwealth Bank has made two major announcements in recent weeks: its full-year profit result last Wednesday, and the appointment of a new CEO, Ian Narev, to replace the retiring Ralph Norris at the end of November.

So what do these announcements mean for the Commonwealth Bank (ASX:CBA) and should your self-managed super fund own CBA?

First, let’s take a look at the results.

Cash profit for the full-year (the preferred way of reviewing bank results) was up 12% to $6,835 million. In the second half of the fiscal year ended June, cash profit was up 4.9% to $3,500 million, compared with $3,335 million in the first half of that financial year.

Positives from the result:

  • Return on equity (ROE) of 19.5% (up from 18.7%);
  • Positive ‘jaws’ – income grew at 4%, while expenses only grew at 3%;
  • The cost to income ratio continued to decline – it’s down to 38.9% in the retail bank;
  • Net interest margin improved to an underlying 2.15% in the June half (from 2.04% in the Dec half);
  • No signs of any problems in the credit quality of the loan book; and
  • For the year, dividends are up 10.3% to $3.20 per share.

Negatives were:

  • Market share losses in the second half in home loans, business loans and deposits – National Australia Bank has the momentum;
  • Trading income (in CBA’s institutional bank) was weak; and
  • CBA had a relatively subdued outlook statement – further illustrated by the lack of real revenue growth (outside interest margins) in the second half.

Overall, a solid, predictable and conservative result from a ‘real’ blue-chip.

As a yield play, it’s hard to go past CBA with its high payout ratio of fully franked dividends and consistency of earnings. While I have been warning that in the medium-term Bank ROEs are on the way down, CBA’s result shows no sign of this, as this chart demonstrates.

On the subject of yield, it’s worth re-stating just how much value there is in CBA shares as an income stock for superannuation funds. Using Friday’s closing price of $48.56 and a conservative forecast of a 5% increase in dividends per share next year to $3.36, the effective dividend yield (due to the franked credits) are as follows:

  • Dividend yield (normal): 6.92% pa
  • Effective dividend yield in accumulation: 8.4% pa
  • Effective dividend yield in pension: 9.88% pa

As for CBA’s incoming CEO, there’s been quite a lot written about Ian Narev, mostly because he’s ex-McKinsey’s with a background in mergers and acquisitions. He led the CBA’s acquisition of Bankwest and news reports suggest we can expect Mr Narev to embark on a round of acquisitions when he takes the helm. Let me say, this commentary is particularly ill-informed and way off the mark. This won’t happen.

I expect that when Ian takes over, it will be pretty much ‘steady as she goes’. While there may be one or two long overdue changes in the senior executive ranks, acquisitions will continue to be opportunistic. Buying a bank like Bankwest at below ‘book value’ and booking a profit on acquisition was purely opportunistic – almost unheard of in banking in the global arena.

So, where does this leave CBA compared with its peers?

Certainly, NAB has the momentum with increasing market shares in key product lines, and a positive June quarter update to the market last week. What worries me about NAB’s strategy is that sustainable market share gains in Australian banking are incredibly difficult to execute and that the problems (that is, potential write-offs from bad loans) won’t show up for three or four years. Further, I still can’t understand what their plans are for their sub-scale banks in the UK, and their US mid-west agricultural banks.

Westpac and ANZ will deliver their June-quarter updates to the market shortly, and we will get a much better handle on just how much real income growth is occurring. Of the two, I prefer ANZ’s strategy for measured expansion into Asia, and I rate their senior executive team more highly.

Buy CBA for steady, reliable, tax effective income. In a bull market, it may lag the other banks up, however, its earnings reliability makes it exactly what a ‘blue-chip’ should be.
Disclosure: I and/or my SMSF own shares in CBA, ANZ, NAB and Westpac.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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