Income Report / Income Report; A look at Australia’s favourite income stock – CBA (CBA, IAG, GMA)

By Market Matters 06 February 19

Income Report; A look at Australia’s favourite income stock – CBA (CBA, IAG, GMA)

Market Matters Income Report 6th February 2019

The market is trading higher again this morning, backing up a very bullish session yesterday. Some tentative selling amongst the banks being offset by buying elsewhere. The RBA Governor  Philip Lowe is delivering a speech (12.52pm) and the market is liking it. He see’s interest rates more evenly balanced now, effectively removing the tightening rhetoric. “Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced,” Lowe said.  Lower rates = good for asset prices and the RBA now doing their best to help support a languishing property market.

There are clearly a lot of moving parts to the market at the moment on a macro level and of course company reporting is also creating volatility. When I stand back and look at the market since the August 2018 high of 6373, we’ve seen a ~15% plunge down to 5410 on Christmas Eve and now we’ve seen an ~11% rally to trade above 6000. That’s an extreme swing between pessimism and optimism in a short window – ultimately a tough environment.

ASX 200 Chart

Over the past week, the Income Portfolio added +1.16% while in the current financial year to date, it is up 1.34% vs the benchmark (RBA + 4%) of 3.3% while the ASX 200 accumulation (including dividends) is +6.37%.  Since inception, the portfolio is tracking at 4.87% p.a. vs the 6.5% p.a. benchmark. In the past week we saw strong performances from the banks, Alumina and Perpetual, while also picking up dividends from MCP and NB Global Income Trust.

Commonwealth Bank (ASX:CBA) Result

CBA reported their first half numbers this morning, and as I type, CEO Matt Comyn is talking through them with shareholders. After the big ‘pop’ in share price yesterday, the stock is trading down ~2% today.  

A quick look at the numbers….about 2% below consensus expectations at the profit line.

The clear observations we take from the result is that income growth remains a problem in a period of low credit growth and ongoing pricing competition for new home loans. That’s pretty obvious and is a trend across the sector.  They have / and will continue to manage this through re-pricing of variable home loans and aggressive cost cutting measures.  Income growth for the period was just 1% from 2H18 to 1H19 from continuing operations and we saw the net interest margin come under pressure – falling by 4bp over the period due to the confluence of competition and higher funding costs. The higher funding costs provide some justification for out of cycle rate hikes…The better news for CBA is that a lot of people are putting money with them  -  deposit growth was twice as much as loan growth!

They continue to do a good job on costs and that focus will continue at a stronger pace by the sound of it, plus they had a better capital position (Tier 1 at 10.8%) than expected. The higher the capital position, the better for hybrid holders (such as the MM Income Portfolio). Asset quality across their book remains strong, however there are some slight signs of deterioration with past due home loans increasing and new impaired loans also up a tad on the period.

Key takeaways; We could look at the result in two ways;  1. These guys are delivering effectively no growth, but maintaining earnings in a tough environment or 2. There are only so many costs that can be pulled, and if conditions deteriorate then earnings will start heading backwards.

The argument should be anchored to current pricing / valuation –i.e. banks are clearly cheap relative to the market and relative to their historical valuations – that’s known, and the outcome from the RC has clearly been more favourable, however markets can get ahead of themselves and yesterday’s rally was a big one. We own the banks, have good weightings across our portfolios but we certainly won’t fall into the trap of ‘not selling strength’.  Banks are priced for no growth so any improvement in underlying economic trends in Australia i.e. housing and they’ll rally. That said, they’re certainly not priced for negative growth which could play out. A trade to keep on top of.

Commonwealth Banks (ASX:CBA) Chart  

Genworth (ASX:GMA) Result

GMA delivered their FY18 set of numbers this morning and the stock is trading up ~6% at time of writing. The result was okay, it’s just the market positioning was very negative. Consensus on this stock is limited so we need to anchor the result to ‘trends’ from recent reports noting this is a fairly complicated business – I’ll try and hit the high notes;

Underlying profit came in at $93.9m which was slightly better than around $90m we were looking for. The dividend of 9c  did the trick and for the full year they’ve paid out 33cps plus franking equating to ~47c, including the special dividend paid in August. The key to the result was a lower Q418 loss ratio and a lower guided loss ratio for FY19 . In simple terms, the loss ratio is the ratio of losses to gains. So for every $1 they collect in premiums they have guided to losing somewhere between 45c and 55c for FY19. In FY18 this number came in at  51.9% helped by a better outcome in Q4 which was  48.2% (seasonal factors do come into play here). GMA have about $800m in excess capital and they’ve just announced a new $100m buy-back program, which should be supportive of the share price. 

The chart below shows the impact of the last buy-back on the share price,  and importantly, the decline when it stopped.

Genworth (ASX:GMA) Chart

The GMA result always provides a good look through on the more pointed end of housing - we can see from the chart below that fewer new loans have high LVR’s which require mortgage insurance. Banks don’t really want the business.

The other area that’s interesting is around delinquencies, and we’re not seeing a meaningful uptick here (yet) – again, a trend to monitor.  

Lastly, Harry takes a look at  Insurance Australia Group (ASX: IAG)

While we don’t hold IAG in the MM Income Portfolio, it is a popular income stock and today they printed their half year results before the market this morning -  the stock is trading up ~4% at time of writing.  They  managed a big beat at the top line, managing premium growth of 4%, well above expectations however this was nearly exclusively driven by rate increases and not adding customers. A beat in underlying margin helped drive a beat at the profit line as well. The underlying margin came in at 16.2%, above the streets expectations of 15.9%

Here’s the numbers;

Always a messy presentation with IAG, and today is no different. Claims costs climbed over the allowance – although this was flagged following the Sydney hailstorms in December.  Guidance for the full year was maintained with gross written premium growth of 2-4%, and margins of 16-18%.

Key takeaways; A decent result, one the market didn’t really anticipate hence the move higher today. Costs will continue to be key for IAG, and the cost out program they embarked on recently is taking longer than expected which could frustrate the market. Underlying margins though do seem to be trending in the right direction.

Insurance Australia Group (ASX: IAG) Chart


Conclusion (s)

We remain comfortable holders of CBA now and would be buyers of any weakness below $70

Trends in GMA are improving and the buy-back should help
We have no interest in IAG at these levels

Have a great day!

James / Harry & the Market Matters Team


Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Friday, or after the session when positions are traded.


All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 06/02/2019

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