Do CBA shares justify their 'valuation premium' following the bank's Q3 update?

A woman in a bright yellow jumper looks happily at her yellow piggy bank representing bank dividends and in particular the CBA dividend

Commonwealth Bank of Australia (ASX: CBA) shares were under pressure on Thursday.

The banking giant’s shares ended the day over 2% lower at $117.09.

Investors were hitting the sell button in response to the bank’s third quarter update.

CBA reported a 1% decline in operating income for the three months ended 31 March. This reflects one less day in the quarter and slightly lower net interest margins due to continued competitive pressures and customers switching to higher yielding deposits.

This ultimately led to Australia’s largest bank reporting an unaudited statutory net profit after tax of $2.4 billion. This is down 3% on the first half average and 5% on the prior corresponding period.

Also weighing on CBA shares were its rising arrears. While its balance sheet remains strong, CBA’s arrears increased across home loans, credit cards, and personal loans. This was largely blamed on cost of living pressures.

Has this pullback created a buying opportunity for investors or should they stay clear of the big four bank? Let’s find out.

Are CBA shares good value or overvalued?

The team at Goldman Sachs has been looking over the result and was reasonably impressed, noting that its profits are run-rating ahead of second-half expectations. The broker said:

Cash profit from continuing operations in 3Q24 of c. A$2.4 bn was down 3% vs. 1H24 quarterly average and run-rating c. 4% ahead of what was implied by our prior 2H24E forecasts largely due to outperformance on the BDD charge. PPOP was in line with expectations.

However, unfortunately this still doesn’t justify the significant premium that CBA shares trade at compared to the rest of the big four banks. Goldman adds:

While CBA’s volume momentum in housing lending has improved and BDDs charges remain benign, we do not believe this justifies the extent of its valuation premium to peers, and note the 52% 12-month forward PPOP premium it is currently trading on versus peers (ex-dividend adjusted), compared to the 24% 15-year average.

In light of this, the broker has reiterated its sell rating with an improved price target of $82.61 (from $81.98). Based on the current CBA share price of $117.09, this implies potential downside of approximately 30% for investors over the next 12 months.

The broker then concludes:

Coupled with i) a business mix that leaves it more exposed to the current competitive environment, and ii) while CBA has historically done a good job in balancing investment and productivity, we do not think it can escape elevated FY24E cost pressures given heightened inflation; we reiterate our Sell recommendation.

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