Hong Leong Bank Bhd
(July 13, RM13.44)
Upgrade to hold with an unchanged target price (TP) of RM13: We are upgrading HLBB from “reduce” to “hold” as we think that the challenging outlook has been largely priced in, following the decline in its share price in 2014 and year-to-date (YTD) 2015. Furthermore, its calendar year 2016 (CY16) price-earnings ratio (PER) of 9.7 times is below the sector’s 10.8 times. 

Nevertheless, we believe the operating environment for HLBB will continue to be tough, with constant pressure on its margins and the slowdown in the industry’s loan growth. We retain our dividend discount model-based TP (cost of equity of 10.4%, long-term growth of 4%). 

The share price fell 2.9% in 2014 and 4.6% in YTD 2015. Following this, we think the negative earnings outlook, arising from margin contraction and an upturn in credit costs, has been priced in. Its CY16 PER of 9.7 times is also below the sector’s 10.8 times. 

HLBB’s share price has slid over the past two years (by 2.6% in 2013 and 2.9% in 2014) as well as YTD 2015 (by 4.6%). Following this, we think that the downside risks are capped as it is now trading below the sector’s average valuation, with a CY16 PER of 9.7 times (versus the industry’s 10.8 times) and price-to-book value of 1.3 times (sector: 1.4 times). Its CY15 dividend yield is decent at 3.1%, although it is below the industry’s average of 4.4%. The bank, indeed, showed some improvement in its financial performance in the third quarter ended March of financial year 2015 (3QFY15). Its loan growth improved from 6.7% year-on-year (y-o-y) in December 2014 to 8.8% y-o-y in March 2015, slightly below the industry’s pace of 9.2%. Non-interest income jumped by 43.4% y-o-y in 3QFY15, reversing the 29% y-o-y plunge in 2QFY15. However, net interest income fell by 3% y-o-y in 3QFY15 due to margin compression. 

Although risks persist in the areas of margins, loan growth and credit costs, the better 3QFY15 financial performance gives us the confidence that the management will be able to reduce the negative impact resulting from the adverse operating environment. 

The key challenges ahead are the expected slowdown in the growth of residential mortgages for the industry, keen deposit competition, thinning margins and an upturn in credit costs. Based on the reasons discussed above, we advise investors to stay on the sidelines. — CIMB Research, July 10

This article first appeared in The Edge Financial Daily, on July 14, 2015.