By Paul Rickard
News that litigation funder IMF Bentham has agreed to fund a shareholder class action against the Commonwealth Bank relating to alleged breaches of the anti-money laundering and counter terrorism financing laws is the latest development to hit the bank. This is one group of CBA shareholders, those who purchased shares between 1 August 2015 and 3 August 2017, effectively suing every other CBA shareholder. Just think of the money and CBA management time that will go into defending this action as CBA shareholders battle it out with each other.
What has been an eye opener in this whole messy saga has been the ferocity with which the public, politicians, media, commentators and CBA’s own shareholders have leapt on to the bandwagon to attack the bank. I am not saying that it is not deserved, but it really does look like a case of the tall poppy syndrome at work. Everything bar the kitchen sink has been dredged up from the past - the financial planning scandal, life insurance definitions with CommInsure, the Storm Financial debacle of 2007, aggrieved BankWest borrowers, leaked internal risk management papers -.to savage CBA’s reputation. Only in Australia.
Since AUSTRAC announced its intention to seek civil penalties for the 53,500 alleged breaches of the Act, CBA shares have shed 9.5% (adjusting for the dividend of $2.30). Compared to its major bank competitors, it has underperformed on a relative basis by between 7.1% against Westpac up to 10.4% against the National Australia Bank.
Major Bank Returns post AUSTRAC
The questions for investors are: is the fall in share price, which has reduced CBA’s market capitalisation by a staggering $13.8 billion, enough and if so, is CBA now a buy?
One of the methods used to compare the value of different banks is earnings multiples. Others include price/book ratios and the discount or premium to the assessed target price. On an earnings multiple basis, CBA has traded at a premium to the other major banks at times as high as 35% and rarely below 15% over the last five to seven years.
CBA attracted a premium price because it is the market leader or number two player in almost all of the major banking categories (home loans, retail deposits, credit cards, and wealth management); it has the strongest balance sheet; it is the clear leader in technology, having invested in both customer applications and its core banking platform; and arguably, it had the best management team. For shareholders, it delivered the highest return on equity.
However, this premium has now evaporated. As the following table of major broker forecasts shows, CBA is trading on a multiple of 12.8 times FY18 earnings, almost the same as the other major banks.
Major Banks - Forecast Earnings and Dividend Yields (source FN Arena)
On a prospective yield basis, CBA is now up near 6%, higher than the ANZ.
What do the brokers say
The major brokers remain unenthusiastic about the Commonwealth Bank. While most see moderate upside potential in the share price, with the consensus target price of $79.47 a 7.8% premium to yesterday’s closing price, there are no buy recommendations. Of the eight major brokers sampled by FN Arena, there are five neutral recommendations and three sell recommendations. Morgan Stanley currently has the lowest target price of $72.00.
CBA - Broker Recommendations (source FN Arena)
While I would like to think that CBA at the same multiple as its peers looks very attractive, because this saga is going to drag on for such a long time, thereby distracting management and creating uncertainty, CBA might have to trade at a discount first to attract buyers. APRA is yet to name the panel members for its independent prudential enquiry, which is expected to take six months from commencement. In relation to AUSTRAC, after CBA lodges a defence in December and AUSTRAC responds in March, a directions hearing has been set for 2 April 2018. It may be a year or more before the size of the fine is announced, and some years before the proceedings of shareholder class actions wind up.
In this environment, it is going to be very hard for CBA to get clear air.
Perhaps the appointment of a new CEO, which is now almost certainly going to be an external candidate, could be the catalyst for the public (and the market) to move on and allow CBA to focus on growing revenues and profits.
Until this happens, the risk is that CBA is going to underperform its peers. Buyers can be a little patient.
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