Is Commonwealth Bank of Australia’s dividend safe?

Commonwealth Bank of Australia (ASX: CBA) is undeniably Australia’s biggest bank, commanding a market capitalisation of $125.2 billion, which makes it the most valuable stock on the S&P/ASX 200 Index.

Early last week, CBA released a solid set of 2016 half-year results, demonstrating why it is regarded as one of the world’s best banks. With its shares continuing to fall post results, I believe now is the time to buy shares in this profit generating machine as a great dividend-producing investment.

2016 results

2016 results came in better than expected with the bank reporting cash net profit after tax (NPAT) (a key measure of profitability) was up 4% on the prior corresponding period (pcp) to $4.8 billion. Statutory NPAT came in 2% higher on the pcp, whilst return on equity decreased 140 basis points to 17.2% (largely due to the effects of a $5.1 billion capital raising carried out last year).

Pleasingly, however, CBA’s capital management efforts led to a 100 basis point increase to its Common Equity Tier 1 (CET1) ratio which now stands at 10.2% on the Australian Prudential Regulation Authority (APRA) basis of calculation, sitting well above the minimum 8% CET1 requirement of the group.

Accordingly, CBA’s 2016 half-year results show that, despite the ongoing market volatility, it continues to generate solid earnings growth. This should augur well for its dividend.

Dividend yield

Investors often speak of bank shares and dividend yields hand-in-hand; with Australian banks providing some of the highest payout ratios in the world, it’s easy to see why it is virtually impossible to recommend Australian banks and not mention their dividend yields. CBA is no exception.

Last week, CBA announced a fully-franked interim dividend of $1.98 per share ($2.83 gross of franking credits). Whilst the dividend was flat compared to its 2015 interim dividend, the key takeaway is that it wasn’t cut. With APRA requiring banks to hold more capital buffers under its recent reforms, speculation was mounting that CBA, alongside each of Australia and New Zealand Banking Group Limited (ASX: ANZ), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC), would be forced to cut its dividend. However, as noted above, CBA didn’t cut its dividend, instead flexing the strength of its balance sheet and maintaining the interim dividend at 2015’s corresponding amount.

Importantly, CBA’s results indicate that the dividend has room to grow. The interim dividend represents a payout ratio of 70.8% of cash NPAT, coming in at the lower end of its target payout range of 70%-80% of cash NPAT. If we assume last year’s final dividend of $2.22 per share is maintained, CBA currently trades on a cash yield of approximately 5.7%. When you include the benefits of Australia’s imputation system, the gross yield spikes to 8.1%, easily trumping most other cash alternatives.

Although CBA’s shares trade ex-dividend today (16 February), meaning investors won’t receive the benefit of the 2016 interim dividend if they purchase after yesterday’s close, management should implement its DRP neutralisation purchases over the next month to offset the dilutive effects of its DRP.

Accordingly, buying CBA after its ex-dividend date still allows investors to reap some benefit from the dividend as the loss in share price (from trading ex-dividend) has historically been recovered in subsequent weeks. As such, buying CBA today should not be prohibitive to the long-term thesis that it will continue to provide a juicy income stream.

Foolish takeaway

Although there might be more lucrative dividend yields on offer in other sectors, CBA is one company which should be part of anyone’s core portfolio. Whilst the bank isn’t as cheap as it could be, the fact that earnings growth continues in a subdued growth environment, amidst regulatory change, suggests that it is well-poised to navigate difficult trading conditions and come out ahead. As such, CBA is one stock I’ll be watching today!

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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