Valuation Risks Loom Large Over Australia's Top Bank CBA's First-Half Earnings

As the dust settles on Commonwealth Bank of Australia's (CBA) first-half earnings, investors are left wondering if the bank's valuation is sustainable. With a share price that has surged by nearly 40% this year, CBA is trading at a premium compared to its historical averages and industry peers. But is this rally built on solid fundamentals, or is it a house of cards ready to tumble?



CBA's first-quarter update showed cash net profit after tax (NPAT) of approximately $2.5 billion, which was flat year over year but represented a 5% increase compared to the quarterly average of the FY24 second half. Operating income increased by 3.5%, thanks to profitable volume growth, while operating expenses grew by 3% due to wage inflation and increased investment spending. However, the question remains: can CBA maintain this momentum, or are there storm clouds gathering on the horizon?



One of the main concerns for CBA and other banks is the potential impact of an RBA rate cut on net interest margins and profitability. A decrease in interest rates could compress margins, challenging profitability even if lending increases. This is because lower income from lending activities may not be offset by a decrease in the cost of deposits, resulting in a narrowing of the net interest margin. This could negatively impact CBA's profitability, as net interest income is a significant contributor to the bank's overall earnings.

Moreover, if banks struggle to justify their high valuations, investors might rotate into mining stocks, where strong commodity prices could offer better returns. This could further threaten CBA's frothy valuations, as investors seek higher growth opportunities elsewhere in the market.

UBS, for instance, has a sell rating on CBA's shares, with a price target of $110. This implies that the broker believes the CBA share price could fall by 30% within the next year. UBS has noted that CBA is trading at valuation ratios significantly higher than it has historically, with a price-to-book value of around 3.2x for FY26 and a P/E ratio of more than 25x FY26's estimated earnings. The broker predicts that CBA can grow its profit steadily between FY25 and FY29, but net profit is only expected to rise by 14% during that time period, which may not be enough to sustain the current earnings multiple.

In conclusion, while CBA's first-half earnings have been solid, there are significant valuation risks looming on the horizon. An RBA rate cut could negatively impact CBA's net interest margins and profitability, potentially leading to a decrease in the bank's valuation if investors seek higher growth opportunities elsewhere in the market. As investors, we must remain vigilant and monitor the market and economic conditions to determine the extent to which these factors influence CBA's share price.