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Broker tips Commonwealth Bank of Australia to undertake $5bn+ share buyback

It’s hard for Commonwealth Bank of Australia (ASX: CBA) to find friends in this environment as more skeletons fall out of its closet at the Banking Royal Commission amid growing warnings by analysts that the sector is facing potential profit downgrades next month.

But Australia’s largest mortgage lender could become its own best friend if CLSA is right in tipping a $5 billion plus share buyback from the Commonwealth Bank that could be funded by the spin-off of its investment management business Colonia First State Global Asset Management (CFSGAM).

That could certainly help its sagging share price as investors have been reluctant to buy the dip even as the stock appears to be trading at bargain levels not seen in a very long time!

Who can blame them? It takes a brave investor to try to catch a falling knife, particularly given that the risk of a profit downgrade looms large with Commonwealth Bank’s peers Australia and New Zealand Banking Group (ASX: ANZ), Westpac Banking Group (ASX: WBC) and National Australia Bank Ltd. (ASX: NAB) handing in their profit results next month.

The float of CFSGAM could fetch $4 billion and could mirror what Westpac did with BT Investment Management Ltd (ASX: BTT).

The IPO could even be an earnings accretive transaction for Commonwealth Bank given that the bank trades on a consensus price-earnings (P/E) multiple of around 12.5 times, when CLSA is predicting CFSGAM could be listed on a P/E of 15 times.

What’s more, an off-market buyback could even allow the bank to use its surplus franking credits, which CLSA estimates at $1.2 billion or 71 cents a share.

The divestment of CFSGAM also makes strategic sense for the bank as the broker points out that global fund managers are increasingly being divided into two camps – those with large global scale or boutiques with superior performance.

CFSGAM sits somewhere between the two and the global funds business lacks clear synergies with Commonwealth Bank’s core banking business.

It’s also getting increasingly difficult for the bank to attract and retain top fund managers in the business under this diversified structure, in large part because high performing stock pickers want an equity stake in the funds business and not a large banking group.

I don’t think anyone would argue with the strategic rational for the divestment, but I wonder if a circa $5 billion share buyback is enough to turn sentiment towards the $128 billion market cap bank.

Such a buyback is unlikely to give Commonwealth Bank a meaningful uplift in earning per share (EPS), particularly in the face of a weakening lending environment and potential large compensation bills from the royal commission and class action lawsuits.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of National Australia Bank Limited. 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 Scott Phillips.

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