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Here's how CBA shares could crack $100

Nicki Bourlioufas  |  19 Jan 2017Text size  Decrease  Increase  |  

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While the Commonwealth Bank may continue to benefit from the halo effect of the surprise US election result, several factors could cap the big bank's run.

 

Bank shares have had a strong run this month, but analysts are mixed on whether the nation's biggest, the Commonwealth Bank of Australia (ASX: CBA), could strike $100 this year after an attempt was made almost two years ago.

Commonwealth Bank shares have hit as high as $85.65 this year, which is already at the top of many analysts' forecasts.

Other big bank shares have jumped too, about 20 per cent since the US presidential election. Following the price rises, many brokers and analysts have moved to Hold or neutral recommendations as the shares became more expensive.

Investors have propped up the stock after a hard year in 2016. Commonwealth Bank shares hit as high as $96 almost in March 2015 but fell as low as $69 in September 2016 when markets dropped ahead of the US election in early November.

David Ellis, head of Australian banking research at Morningstar, says a positive effect is rolling across the globe from the US, with financial stocks, especially big banks, benefiting from the halo effect of the surprise US election result and the potential kick-start to US economic growth.

"Stocks are up, which should help capital markets revenue. We've also seen an increase in long-term rates and another hike from the US Federal Reserve, which should finally start to boost net interest margins," he says.

Ellis says the Commonwealth Bank, riding the wave of optimism, could keep running towards $100 "but we would need to see some earnings upgrade catalyst". The bank reports its results for the first half of fiscal 2017 on 15 February, and he notes the potential for an upside surprise.

"We expect a cash profit around $4.94 billion, a little higher than consensus of about $4.85 billion. If the CBA reports a cash profit of $4.9 billion or above, then I would expect earnings upgrades from other analysts. Earnings upgrades will depend on the outlook for net interest margins and bad debts," Ellis says.

"A lot of focus will be on the dividend--we expect an interim dividend of $2.01 per share with consensus at around $1.98."

At current prices, Commonwealth Bank shares are yielding around 5 per cent, but the other banks are yielding more, with National Australia Bank (ASX: NAB) at 6.3 per cent, Westpac (ASX: WBC) at 5.7 per cent, and Australia and New Zealand Banking Group (ASX: ANZ) yielding 5.2 per cent.

Another positive for the Aussie major banks is the expected watering down of the forthcoming Basel IV capital rules.

"The Aussie banks are well capitalised and well placed to cope with additional capital requirements. The Australian Prudential Regulation Authority will likely apply a generous implementation period of three to four years for the Aussie majors to be 'unquestionably strong,'" Ellis says.

"Despite the overall negative view of the Australian economy the banks are very well placed to leverage any growth in the economy, particularly in the more populous and prosperous eastern states dominated by Sydney, Melbourne and Brisbane."

However, slowing economic activity in Australia, higher funding costs, pressure on net interest margins, and increasing bad debts could cap the big banks' run.

"Widespread competitive, funding and regulatory pressures continue to squeeze net interest margins, but recent loan repricing partially offsets this. Further loan repricing is likely if margin pressure intensifies despite increased political scrutiny," Ellis says.

"Australia's political landscape has changed for the worse and we are increasingly cautious of the risks to the profitable banking oligopoly. The concerns stem from increased public and political scrutiny of the lenders and tougher regulatory oversight.

"Nevertheless, we believe the major banks' pricing power will ensure return on equity is maintained above the cost of equity, with recent loan repricing evidence the negative impact to net interest margins can be managed."

For investors looking to buy the big banks, Ellis says they are not cheap and look fairly valued around current levels. Ellis's major bank valuations are $29 for ANZ, the Commonwealth Bank at $85, NAB at $31 and Westpac at $35.

But if the Commonwealth Bank makes a run to $100, it could get a lot more expensive. As at 12 January 2017, the 14 analysts surveyed by Thomson Reuters offering 12-month price targets had a median target of $78.44, with a high estimate of $89.00 and a low estimate of $68.00.

So, not one of those analysts had $100 in sight over the short term. Having said that, analysts have been upgrading their estimates to follow market movements, rather than predicting them.

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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

© 2017 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

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