CIMB Group Holdings Berhad TP: RM7.50 (+8.4%) Sluggishness All Around

A Member of the TA Group MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048 COMPANY UPDATE Wednesday, August 13, 2014 FBM KLCI: 1,850.39 Sector: Finance CIMB Group Holdings Berhad TP: RM7.50 (+8.4%) Sluggishness All Around THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* Last Traded: RM6.92 TA Research Team Coverage Tel: +603-2167 9610 liwong@ta.com.my www.taonline.com.my HOLD CIMB s share price has underperform the KLCI in the past 24 months. In tandem with some of its foreign shareholders exiting the stock in the earlier part of the year, the constant flow of unfavorable news has dampened the group s earnings prospects. Recent announcements of the Dato Sri Nazir Razak relinquishing his position as group CEO and a possible mega merger with RHB Cap and MBSB did not help buoy confidence in the stock. Although we note of CIMB s increasing attractiveness from a valuation standpoint, the shortage of earnings catalysts, augmented by downside risks stemming from deterioration in regional asset quality and compression in NIM for the remaining part of the year will justify our downgrade for CIMB from buy to HOLD. The stock is currently trading at FY15 PBV of 1.7x, a slight premium to industry s average PBV of 1.6x. Compared to its 10-year PBV valuation cycle, it is currently trading below the mean of 1.7x. We expect sluggishness in its regional operations to persist. CIMB Niaga recently reported weak 2Q and 1HFY14 results as net profit dipped 22.1% QoQ and 8.5% YoY respectively. Similarly, CIMB Thai reported YoY and QoQ decline in net profit. Of bigger concern, we opine, is the surge in impairment losses on loans and assets, suggesting that asset quality could be worsening. As competition deepens ahead of Basel 3 s Liquidity Coverage Ratio (LCR), we foresee further NIM compression due to a rise in funding costs. Elsewhere, management appeared less upbeat on the corporate and SME segment. CIMB expect corporate loans to remain weak and grow at a slower pace than the retail segment. The IB business also remained lacklustre due to the lack of execution and listing of any significant IPOs. Management does not expect any major improvement in corporate and IB activities for the remaining part of the year. Given the tepid loans growth to date, management has lowered its loans growth guidance for CIMB Niaga to around 9-10%. Compensating for softer regional operations, we foresee the group s domestic operations to stay robust, underpinned by the consumer segment. Elsewhere, cost initiatives appear to be going as planned with total overhead expenses reducing on a YoY and QoQ basis. However, we believe that meeting the targeted 55% cost to income (CTI) ratio may be challenging owing to softer topline growth for certain segments. Share Information Bloomberg Code CIMB MK Stock Code 1023 Listing Main Market Share Cap (mn) 8336.5 Market Cap (RMmn) 57688.6 Par Value 1.00 52-wk Hi/Lo (RM) 8.22/6.67 12-mth Avg Daily Vol ('000 shrs) 9427.6 Estimated Free Float (%) 38.6 Beta 1.47 Major Shareholders (%) Khazanah - 29.2 EPF - 14.6 Mitsub UFJ Financial Group - 4.6 Forecast Revision FY14 FY15 Forecast Revision (%) (12.7) (11.6) Net profit (RMm) 4,163.9 4,579.0 Consensus 4,636.0 5,278.0 TA's / Consensus (%) 89.8 86.8 Previous Rating BUY (downgraded) Financial Indicators FY14 FY15 ROE (%) 13.3 13.7 ROA (%) 1.1 1.1 CTI Ratio (%) 66.6 67.1 Gross Impaired Loans Ratio (%) 2.8 2.8 LD Ratio (%) 86.8 87.3 BV/ Share (RM) 4.1 4.2 Price/ BV (x) 1.7 1.7 Share Performance (%) Price Change CIMB FBM KLCI 1 mth (1.1) 7.7 3 mth (5.7) 13.0 6 mth (3.4) 14.9 12 mth (4.9) 17.1 (12-Mth) Share Price relative to the FBM KLCI In this report, we raised credit charge assumptions, cut NIM and reduced growth assumptions for the non-nii segment. Taken together, we cut our FY14/15/16 net profit forecasts by 12.7/11.6/9.1% to RM4,163.9/4,579.0/5,105.7mn from RM4,772.1/5,180.1/5,616.9mn respectively. This translates to FY14/15/16 ROE of 13.3%/13.7%/14.4% for FY14/15/16 slightly below management s budgeted 13.5% for this FY. In tandem with the earnings downgrade, we reduce CIMB s TP to RM7.50 from RM8.40. Our TP translates to an implied FY15e PBV of 2.0x. Lingering concerns Page 1 of 7 Source: Bloomberg

CIMB s share price has underperform the KLCI in the past 24 months. In tandem with some of its foreign shareholders exiting the stock in the earlier part of the year, the constant flow of unfavorable news from softer contributions from Indonesia operations due to steep depreciation of the Rp and potential implementation of new rule to cap foreign shareholding level to weaker-than-expected corporate and IB business flows (despite healthy pipeline of deals) continued to dampen the group s earnings prospects. Recent announcements of the Dato Sri Nazir Razak relinquishing his position as group CEO and a possible mega merger with RHB Cap and MBSB did not help buoy confidence in the stock as well. Figure 1: CIMB vs. KLCI Source: Company, Bloomberg, TA Research Figure 2: Foreign shareholding level Source: Company, TA Research Downgrade despite attractive valuations Although we note of CIMB s increasing attractiveness from a valuation standpoint, the shortage of earnings catalysts, augmented by downside risks stemming from deterioration in regional asset quality and compression in NIM for the remaining part of the year will justify our downgrade for CIMB from buy to HOLD. The stock is currently trading at FY15 PBV of 1.7x, a slight premium to industry s average PBV of 1.6x. Compared to its 10-year PBV valuation cycle, it is currently trading below the mean of 1.7x. Page 2 of 7

Figure 3: Rolling 10-year PBV (x) Source: Company, Bloomberg, TA Research Sluggish regional operations to persist CIMB Niaga continues to disappoint. The bank reported weak 2Q and 1HFY14 results as net profit dipped 22.1% QoQ and 8.5% YoY respectively. Amid challenging macroeconomic and business conditions, growth prospects are dimmed by high funding costs, lower fee income due to new OJK regulation, slowdown in demand and increased provisions. Similarly, operations in Thailand reported YoY and QoQ decline in net profit. The weak operating environment is exacerbated by political uncertainties, which had resulted in softer loan activities and investments. We predict a 10% decline in CIMB Niaga s FY14 PBT. Coupled with a further 8% depreciation in the Rp, the impact would translate to a 16% decline in PBT in MYR terms. This would result in lower PBT contribution of around 28% from CIMB Niaga vs. 30% in FY13 and 32% in FY12. Asset quality at risk Of bigger concern, we opine, is the surge in impairment losses on loans and assets, suggesting that asset quality could be worsening. Although asset quality of the group s domestic business is expected to stay relatively benign, CIMB Niaga and CIMB Thai both reported sharp increases in the gross nonperforming loans (NPL) to 3.0% and 3.1% in June 2014 from 2.2% and 2.5% in December 2013. Management noted that the economic slowdown had impacted on the borrowers repayment ability. Management also noted that while the exercise of high credit risk underwriting standards and risk management policies are ongoing, activities around monitoring, collection and managing all accounts closely have been ramped up. Given concerns over further deterioration in CIMB Niaga and CIMB Thai s asset quality, we raise our credit charge assumption to 36 bps closer to management s guidance of between 35 and 40 bps. We expect credit charge to improve to 24 and 19 bps in FY15 and FY16. Despite that, the headline gross impaired loans ratio should improve to around 2.8% in FY14 from 3.2% in FY13 and 3.8% in FY12. Page 3 of 7

Figure 4: FY13 PBT by country Source: Company, TA Research NIM to be dragged lower by Niaga While a downtrend in NIM is an industry wide phenomena, CIMB has been quite successful in keeping the group s net interest margin (NIM) in check, thus far. In addition to re-pricing of some assets, strategies, which include proactively managing liabilities, where deposit portfolios are rebalanced to strengthen CASA deposits have helped alleviate margin compression. In Indonesia, NIM broadened 4 bps QoQ as CASA deposits advanced 4.4% compared to the 1.4% increase in costlier time deposits. However, as competition deepens ahead of Basel 3 s Liquidity Coverage Ratio (LCR), we foresee further NIM compression due to a rise in funding costs. In Indonesia, the competition is also going to be intensified by the need for banks to maintain the regulatory loan to deposit ratio (LDR) based reserves requirement at 92%. We note that average LDR of the top 5 banking groups in Indonesia currently stands at 89%. That said, management guides that CIMB Niaga s NIM could ease to 5% by year-end from 5.24% currently due to pressure on liabilities. We foresee the decline to have an impact on the group s overall earnings as we cut NIM assumptions by another 5 bps and 2 bps for FY14 and FY15. Figure 5: NIM CIMB vs. industry Source: Companies, TA Research Page 4 of 7

Weaker-than-expected corporate loans, IB business Despite a healthy pipeline, management appeared less upbeat on the corporate and SME segment. CIMB expect corporate loans to remain weak and grow at a slower pace than the retail segment. Elsewhere, the IB business remained lackluster due to the lack of execution and listing of any significant IPOs. Stockbroking volumes and hedging activities also appeared unexciting. Aside from some catalysts from forex trading, remittances and recent pickup in DCM activities, management does not expect any major improvement in corporate and IB activities for the remaining part of the year. Beyond P&L, the group is making significant headway across the region, thanks to the acquisition of RBS. Figure 6: FY13 PBT by division Source: Company, TA Research Figure 7: Non-NII/Total income (%) Source: Companies, TA Research Malaysia consumer ops, the group s saving grace for FY14 Given the tepid loans growth to date, management does not expect CIMB Niaga to meet the budgeted loans growth of 14% for the year and has lowered guidance to around 9-10%. This is in line with our conservative forecast of 10%. Compensating for softer regional operations, we foresee the group s domestic operations to stay robust, underpinned by the consumer segment in areas of mortgages, ASB, HP, cards and enterprise banking. We maintain our loans growth assumption of 11.4% for the group. Page 5 of 7

Supported by the group s domestic network of around 297 bank branches and growing number of its internet and mobile banking services, we believe efforts to cross sell and to play a more meaningful role in the existing customers banking needs would be more effective. Furthermore, we understand that domestic NIM are expected to remain stable with some potential upside due to better pricing discipline. The increase will also be in tandem with management s proactive asset and liability management, where the group focuses in better margin products such as HP loans with floating rate and building of low-cost funds. Successful cost initiatives Cost initiatives appear to be going as planned with total overhead expenses reducing on a YoY and QoQ basis. However, we believe that meeting the targeted 55% cost to income (CTI) ratio may be challenging owing to softer topline growth for certain segments. Figure 8: Cost-income ratio (%) Source: Companies, TA Research Earnings downgrade We envisage potential downside risks outweighing upside in the form of robust domestic retail operations, prudent asset and liability management and effective cost containment efforts. Concerns over worsening of business activities and asset quality in its regional operations along with further NIM compression and weak corporate and IB flows had led to us: 1) raising credit charge assumptions, 2) cutting NIM and 3) reducing growth assumptions for the non-nii segment. Taken together, we cut our FY14/15/16 net profit forecasts by 12.7/11.6/9.1% to RM4,163.9/4,579.0/5,105.7mn from RM4,772.1/5,180.1/5,616.9mn respectively. This translates to FY14/15/16 ROE of 13.3%/13.7%/14.4% for FY14/15/16 slightly below management s budgeted 13.5% for this FY. Valuation and recommendation In tandem with the earnings downgrade, we reduce CIMB s TP to RM7.50 (based on the Gordon Growth Model, cost of equity of 9.0%, FY15e ROE of 13.7% and sustainable long-term growth of 3.0%) from RM8.40. Our TP translates to an implied FY15e PBV of 2.0x. Page 6 of 7

Profit & Loss Statement Key Financial Ratios and Margins FYE 31 Dec (RMm) 2012 2013 2014E 2015E 2016E FYE 31 Dec (RMm) 2012 2013 2014E 2015E 2016E Interest income 13,540.6 14,677.3 15,975.1 17,214.1 18,954.8 Return and efficiency Interest expense (6,144.7) (6,723.2) (8,031.2) (9,166.2) (10,536.1) ROE (%) 15.9% 15.5% 13.3% 13.7% 14.4% Net interest income 7,395.9 7,954.1 7,943.9 8,047.9 8,418.7 ROA (%) 1.4% 1.3% 1.1% 1.1% 1.1% Islamic banking income 1,689.3 1,592.9 1,752.1 1,927.4 2,120.1 Net interest margin (%) 2.6% 2.5% 2.3% 2.1% 2.0% Total non-interest income 4,406.6 4,599.6 5,003.4 5,446.1 5,931.8 Fee-based/total income (%) 12.8% 12.7% 14.5% 15.8% 16.8% Total income 13,491.8 14,146.6 14,699.5 15,421.4 16,470.6 Non-interest/total income (%) 32.7% 31.4% 34.0% 35.3% 36.0% Overhead expenses (7,612.1) (8,457.9) (8,627.0) (9,058.4) (9,511.3) Cost-to-income (%) 64.5% 67.4% 66.6% 67.1% 66.3% Operating profit 5,879.7 5,688.8 6,072.4 6,363.0 6,959.3 Loan loss provisioning (362.3) (726.2) (1,007.8) (766.2) (687.2) Balance sheet Profit before tax 5,638.3 5,849.2 5,426.0 5,958.2 6,633.5 Loans grow th (%) 8.8% 12.5% 11.4% 11.6% 11.8% Taxation (1,281.1) (1,240.4) (1,193.7) (1,310.8) (1,459.4) Gross Impaired Loans ratio (% 3.8% 3.2% 2.8% 2.8% 2.9% Minority interests (12.4) (68.4) (68.4) (68.4) (68.4) Loan loss reserves (%) 82.8% 84.8% 114.8% 114.0% 110.4% Net profit 4,344.8 4,540.4 4,163.9 4,579.0 5,105.7 Deposit grow th (%) 11.4% 6.4% 10.9% 11.0% 12.0% LD ratio (%) 81.7% 86.9% 86.8% 87.3% 87.1% Balance Sheet Statement FYE 31 Dec (RMm) 2012 2013 2014E 2015E 2016E Investment statistics Cash and short-term funds 30,759.9 33,678.9 36,201.7 33,788.8 34,966.3 PER (x) 14.0 13.4 14.6 13.3 11.9 Deposit w ith FIs 4,990.3 3,789.0 4,167.9 4,584.7 5,043.2 PBT grow th rate (%) 8.9% 3.7% -7.2% 9.8% 11.3% Marketable securities 67,660.1 69,579.3 73,382.9 77,402.7 81,651.5 EPS (sen) 52.1 54.5 49.9 54.9 61.2 Total current assets 103,410.3 107,047.2 113,752.6 115,776.1 121,660.9 EPS grow th rate (%) 7.8% 2.5% -12.9% 6.6% 11.5% Net loans and advances 202,137.8 228,431.7 253,168.6 282,550.2 315,846.5 BV per share (RM) 3.81 3.99 4.07 4.18 4.45 Fixed assets 1,711.4 1,698.7 1,715.7 1,732.8 1,750.2 P/BV (x) 1.92 1.83 1.79 1.74 1.64 Intangible assets 9,858.1 9,637.7 9,637.7 9,637.7 9,637.7 DPS (sen) 23.4 29.9 26.1 27.8 31.0 Other long-term assets 19,343.5 24,097.5 19,818.3 20,799.3 21,855.7 Dividend yield (%) 3.2 4.1 3.6 3.8 4.2 Total assets 336,461.2 370,912.8 398,092.8 430,496.2 470,751.0 PBT by geographical segment Customer deposits 247,295.0 263,004.3 291,592.9 323,771.2 362,623.7 FYE 31 Dec (RMm) 2009 2010 2011 2012 2013 Deposits from other FIs 15,522.6 20,727.8 21,764.2 22,852.4 23,995.1 Malaysia 74.0% 52.0% 62.0% 59.0% 61.0% Bills and acceptances 4,257.3 4,713.2 4,854.6 5,000.3 5,150.3 Indonesia 20.0% 35.0% 30.0% 32.0% 30.0% Borrow ings 24,982.8 28,177.1 28,177.1 28,177.1 28,177.1 Thailand 1.0% 1.0% 2.0% 4.0% 6.0% Other liabilities 15,137.2 23,061.7 18,386.4 15,363.2 13,234.6 Singapore n.a. 3.0% 2.0% 3.0% 4.0% Total liabilities 307,194.8 339,684.2 364,775.3 395,164.3 433,180.8 Others 5.0% 9.0% 4.0% 2.0% -1.0% Minority interests 773.3 757.5 825.9 894.3 962.7 Shareholders' funds 28,293.0 30,271.1 32,491.7 34,437.6 36,607.4 Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy or completeness is not guaranteed and opinions are subject to change without notice. This report is for information only and not to be construed as a solicitation for contracts. We accept no liability for any direct or indirect loss arising from the use of this document. We, our associates, directors, employees may have an interest in the securities and/or companies mentioned herein. for TA SECURITIES HOLDINGS BERHAD (14948-M) MENARA TA ONE, 22 JALAN P. RAMLEE, 50250 KUALA LUMPUR, MALAYSIA TEL: +603-20721277 / FAX: +603-20325048 (A Participating Organisation of Bursa Malaysia Securities Berhad) Kaladher Govindan Head of Research Page 7 of 7