Big bank stocks are staging a comeback this morning following yesterday's beating on news of a Royal Commission into the financial industry with Commonwealth Bank of Australia (ASX: CBA) leading the decline with a 2% drop in its share price to $79.43.
But this morning's reprieve could be short-lived, particularly for our largest home lender, as there are reasons outside of the Royal Commission that leave Commonwealth Bank susceptible to further falls.
It's an issue of strength turning into weakness. Morgan Stanley has identified four reasons why Commonwealth Bank has historically traded at a premium over its peers National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC).
The tailwinds have now shifted and the broker is warning that Commonwealth Bank has further to de-rate.
De-rating refers to the increase in the risk assessment for the stock. The higher the perceived risks, the bigger the valuation discount (leading to a lower valuation of the stock).
The four key strengths that are now waning are 1) Strategy, execution and franchise strength; 2) Stronger growth and excess capital generation; 3) Stronger balance sheet and lower risk profile; and 4) Tight share register.
The first point speaks to how well Commonwealth Bank's management has delivered on its strategic plan vs. its peers over the past decade. But this is changing because of the impending change in the CEO, which may well be an external appointment. This adds uncertainty for investors in the near term.
The bank also has the strongest retail banking franchise, according to Morgan Stanley. But this is likely to be somewhat wilted away due to recent concerns about the bank's misconduct (AUSTRAC case) and the scrutiny the Royal Commission will put on the bank's behaviour.
On the second point, Morgan Stanley believes Commonwealth Bank's P/E premium to its peers was justified by stronger earnings per share (EPS) and revenue growth over the past 5 to 10 years.
However, the bank's ability to sustain this is under a cloud with the broker noting the end of the mortgage bull market and growing regulatory and community pressure. This in turn will impact on the bank's dividend flexibility and scope to lift returns though capital management.
The third point is on the Commonwealth Bank's balance sheet. The broker believes the funding advantage the bank had over its peers from having a greater share of domestic savings accounts is less than what it was a decade ago.
Further, analysis done by the broker showed that Commonwealth Bank is not any less vulnerable to an increase in bad debts than Westpac or National Australia Bank, even though the market views Commonwealth Bank as having the lowest credit risk.
Lastly, Commonwealth Bank has the largest proportion of retail shareholders (and still does) compared to the other big banks. Unlike institutional investors, retail shareholders are less likely to sell the stock when it looks expensive.
"However, we believe this source of support for trading multiples is not as strong as it was because the proportion of retail shareholders has fallen and the difference vs. peers has narrowed from ~14% to ~8% over the past decade," concluded the broker.
Morgan Stanley has an "underweight" recommendation on the stock with a price target of $71 a share.
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