Two months ago, on December 10, we recommended buying National Australia Bank shares, and potentially selling Commonwealth Bank shares.
We said that while “Commonwealth Bank deserves its premium rating over National Australia Bank, the 37% difference in price (on a PE basis) is too much and a return to a level of around 20% is on the cards”.
Our argument was largely based on the ‘mean reversion theory’, which says that in a mature, highly regulated, oligopolistic market like Australian banking, it is very difficult for one of the participants to make major competitive gains over the other participants and as a result, their profitability and return on capital will largely be the same. Consequently, pricing (as measured on a PE basis) will largely revert to the mean. With a 2% dividend yield gap and 37% price advantage, the NAB was too cheap compared to the CBA.
What’s happened
In the big rally that has occurred (particularly in January) since we published our report, prices have started to revert and the gap has closed. Using consensus earnings forecasts for the current year, CBA is now trading at a multiple of 14.5 times earnings, and the NAB at a multiple of 11.6. CBA is now only 25% more expensive than the NAB – compared to 37% back in December!
The news from NAB
NAB announced its December quarter trading update last Thursday. Cash earnings of $1.45 billion were up 4% on the average of the previous two quarters, boosted by higher revenue and a fall in bad debts. Revenue rose 3%, following strength in wholesale banking and an improvement in funding margins.
While very much in line with market expectations, there was no bad news in the result. There was a small improvement in the result out of the UK due to a moderation in bad and doubtful debts – one of the main areas of concern for the broker analysts.
With a forecast dividend of 186 cents per share for the year (fully franked), NAB is still trading on a pretty attractive dividend yield of 6.4%.
Commonwealth reports this week
The CBA announces its half-year results on Wednesday morning. Following on from the $1.85bn cash earnings for the first quarter, the market is expecting earnings of around $3.75bn for the December half. The main focus will be whether CBA has been able to deliver “positive jaws” for the half – revenue growth increasing at a higher rate than expense growth.
CBA is trading on a forecast dividend yield of 5.3%, with the market expecting total dividends of 343 cents per share for the year. Wednesday’s profit result will see the announcement of a much higher interim dividend, as the Bank shifts to a policy of roughly equalising its interim and final dividend payments (it announced back in August that its interim dividend would be around 70% of the interim half year profit – which is within the overall target payout range of 70% to 80%).
For any SMSFs looking to “purchase” the dividend (subject of course to the ’45 day rule’), CBA will go ‘ex-dividend’ next Monday – so the last trading day to buy it cum dividend is this Friday.
CBA vs NAB – where to from here?
Although the gap has narrowed, our sense is that there may be a little bit more in this to play out, particularly as market momentum seems to be with the NAB. Its dividend yield just looks too attractive. Further, the main risk to being long the NAB – further bad news from the UK – seems to be fading.
Commonwealth Bank is the premiere bank and deserves its market premium. An extraordinary profit result would see renewed momentum in the stock price – however it is really hard to see what the catalyst for this could be given the very low credit growth environment. The risks on the downside – management complacency or lethargy (it has been the leader now for almost a decade), or a misjudged acquisition.
Bottom line – look for the gap to close further – target CBA to trade at around a 15% premium. Buy NAB.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
