June 14, 2009 Fair Value Estimate: AED 16.13 Recommendation:: Buy Executive Summary Despite a difficult macroeconomic environment, FGB reported better Q1 2009 results. Net profit rose 11.8% q-o-q to AED 750.3mn. The NIM, and fee income increased, and investment losses were lower. In addition, the operating efficiency improved significantly over Q4. We expect a further improvement in Q2 2009 resultss and forecast an EPS of AED 0.56. FGB is strongly capitalised with a total CAR of 17.3%.. The injection of AED 4bn in Tier I capital notes by the Abu Dhabi Government has helped improve the Bank s capital adequacy, providing sufficient resources to finance its future expansion. In addition, FGB is in the process of converting AED 4.5bn in government deposits into Tier II capital, which should further improve its CAR. Following these capital injections, we have increased our long- term loan-growth estimates. The NIMs (after factoring-inn the impact of tighter spreads) are higher than before. In addition, we have raised our fee and commission income estimatess due to increases in advances. We also expect the Bank to continue with its rationalised cost-structure. Overall, these changes result in an increase in our estimate of the Bank s value. Sequentially, delinquencies rose, with the NPL ratio rising 14 bps to 0.7%. The impairment charge on the advances portfolio increased, raising the coverage ratio from 233% to 235%. Due to significant exposure to personal loans and the effects of the continuing economic slowdown, we expect delinquencies to rise and the NPL ratio to deteriorate further in Q2 2009. Valuation: Having increased our long-term growth estimates, while factoring-in the near-term macro economic headwinds, we believe FGB representss an attractive medium- to long term investment. Our weighted average valuation model yields a fair value per share of AED 16.13, implying a 16.4% premium to the current price of AED 13.85. Therefore, we maintain our BUY rating. RESULT UPDATE Share Data Market Cap Price Abu Dhabi General Index Reuters FGB.AD Bloomberg FGB:UH Avg. Volume (52 Week) 1.7mn 52-Week High/Low Shares Outstanding Fair Value Estimate Key Figures Year to 31 Dec Net int. & Islamic Fin. Inc. (mn) Total operating Income (mn) Net Profit ex. one-off (mn) 2008A 2,580.5 4,698.4 3,005.3 2009E 3,184.6 4,966.2 2,808.9 EPS (AED) +/- (%) NIM (%) RoA (%) 2.19 36.0% 3.1% 3.3% 2.04 (6.5)% 3.1% 2.5% RoE (%) 25.6% 16.3% P / E (x) 3.8x 6.8x P / BV (x) 0.9x 1.3x Shareholding Pattern (%) Direct Access Investment Al Nahyan (Al Sheikh Tahnoon Bin Zayed Bin Sultan) Public & Others Relative Performance 35.0 28.0 21.0 14.0 7.0 0.0 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 AED 19.0bn AED 13.85 2,867.6 AED 29..05 / 6.84 1,375.0mn AED 16.13 Apr-09 May-09 Jun-09 FGB Rebased Index 5.9 5.6 88.5 1
Investment Rationale Despite unprecedented financial market conditions, FGB s performance improved in Q1 2009 compared to the fourth quarter. Net profit increased 11.8% q-o-q. Lossess on the investment portfolio fell while fee & commission income was higher. Further, the Bank significantly improved its operating efficiency. The asset impairment charges rose, taking up the coverage ratio to 235%. While macro economic headwinds continue to cloud the near term outlook, we have increased our long-term loan-growth (and related commission & fee income) forecasts; following an injection of Tier I capital by the Government of Abu Dhabi. At the same time, due to the current uncertain financial environment, we retain our conservative estimates for spreads. The stock presently trades at ~1.0x P/B multiple. We believe that this largely factors-in the expected near-term negatives. In view of the Bank s strong franchise and wellvalue to capitalised growth model, we believe that it is capable of delivering significant investors. We have revised our fair-value estimatee upwards to AED 16.13 and, recommend the stock as a Buy. Satisfactory results, better performance expected FGB s net profit increased 11..8% q-o-q to AED 750.3mn, reflecting a 12.2% increase in net interest income and strong growth in fee & commission income. Main drivers of profit growth were the increased operating efficiency and reduced lossess on the investment portfolio. General and administrative expenses declined 28.7% q-o-q to AED 292.7mn, improving the cost-to-income ratio by 10.1pps to 22.2% %. Investment losses also fell from AED 197.7mn to AED 5.4mn. The core-lending business has performed well with the NIM increasing by approximately 28bps to 3.51% compared with Q4 2008, following the Tier I capital injection. The NIM increased despitee a slight 12bps narrowing of the interest rate spread, whichh was a consequence of greater liquidity in the banking system. Fee and commission income (including fee and charges on credit cards) increased 31.2% q-o-q to AED 317.8mn. Other operating income, on the other hand, declined from AED 432.9mn to AED 125.0mn, due largely to non-operating items including lower gains on the sale /revaluation of investment properties. Adverse macro-economic conditions are likely to prevail throughout 2009 and early 2010. Given increasing liquidity in the system, we retain our conservative spread estimates. However, as a result of the loan re-pricing, the NIMs are much higher, than estimated earlier. We forecast a NIM for Q2 2009 of 3.38%, and fee and commission income growth of 1.5-2% q-o-q. Strong Capitalisation, engine for long-term growth FGB s total capital adequacy ratio is a robust 17.3% %. Supported by strong profits, it improved from 14.1% in Q4 2008 following the issue of AED 4bn in Tier I notes to the Government of Abu Dhabi. Further, the Bank is in the process of converting AED 4.5bn deposits of the Abu Dhabi government into a Tier II qualifying loan. Such opportune moves by the Bank have helped reinforce its capital structure which is now sufficiently strong to enable it to continue growing its loan-book and help sustain the impact of rising delinquencies. 2
In Q1 2009, advances weree 5.4% higher q-o-q at AED 83.6bn, while non-trading investments increased 15.9% q-o-q to AED 11.6bn. Given the modest 2.4% growth in deposits over the same period, we believe these increases reflect the effects of the Tier I capital injection. Significantly, the Bank chose to deploy a larger proportion of its additional funds into investments than in advances, indicating the Bank s credit-risk aversion. Therefore, although the Bank s surplus capital could be a key driver for growth in advances in the near-term, we do not expect it to be so, given prevailing uncertainty and the high credit-risk environment. In the next few quarters, we believee the Bank will deploy its excess capital more into investments rather than expanding its advances-basee swiftly. Consequently, for Q2 2009, we forecast loan growth of around 1% q-o-q (28% y-o-y). However, 2011 onwards, we expect the Bank to allow its advances to expand more rapidly than we estimated before the recent capital injection, whichh is likely to result in faster growth in fee and commission income as well. In addition to acting as a catalyst for loan-growth, the capital infusion is likely to result in stronger NIMs. These factors, together with a tighter control of expenses will improve net profitability, which is the main reason for the upward revision in our estimated value for the Bank. NPLs likely to increase, although markdowns likely to moderate FGB s NPL ratio increased from 0.6% in Q4 2008 to 0.7% q-o-q to AED 220mn, increasing the in Q1 2009. The impairment charge on the loan portfolio rose 11.0% q-o-q coverage ratio from 233% to 235%. Given the Bank s large exposure to personal loans, we expect delinquencies to edge higher. However, since FGB has already taken a significant impairment charge in Q1 2009 and has a high coverage ratio, we expect the Q2 charge to be much lower on a q-o-q basis. While the markdowns on the AFS portfolioo in Q1 weree AED 55mn, we expect these to moderate as well, as we believe that substantial price correction is now over, and the markets will now move gradually higher. 3
Valuation We have valued using a combination of Discounted Equity Cash Flow (DECF) and Peer-Based Multiples. We have assigned subjective weights of 70% to our DECF and 30% to our Peer-based Multiple Valuations to calculate our fair value estimate for the standalone entity. We have separately valued investments in properties at 0.5x their book value. Our DECF valuation has been assigned a higher weight as it discounts firm-specific cash flows. These valuation models yield a fair value of AED 16.13 per share for the consolidated entity, representing a premium of 16.4% to the current share price. A significant proportion of this valuation is generated by the standalone banking entity (valued at AED 14.8 per share), with the remainder (AED 1.3) comprising Investment in properties. We maintain our Buy rating on the stock. Valuation Method Discounted Equity Cash Flow (DECF) Peer-based multiple valuation Weighted Average Value per Share Value (AED) 15.6 12.8 Weight (%) 70% 30% Weighted Average Standalone Fair Value Investment in properties Total Fair Value Source: ADCB research 14.8 1.3 16.1 100% We have used a two-stage DECF model with explicit forecasts to 2016. Based on these, we have calculated free cash flows which we have then discounted in order to estimate the fair value of the Company. We have estimated the Cost of Equity using the Capital Asset Pricing Model. The key assumptions underlying our model are as follows: Risk free rate: 4.2% Equity Risk Premium: 6.0% Country Risk Premium: 2.9% Beta: 1.19 Cost of equity: 14.24% Terminal growth rate: 3.5% Based on these assumptions, our estimate of the fair value of equity for FGB is AED 23.5bn. Our DCF model yields a fair value per share of AED 15. 6 based on currently outstanding 1.5 billion fully diluted shares. Sensitivity of fair value estimate, using different rates terminal growth rates: for terminal cost of capital and Terminal growth Terminal cost of equity 15.6 13.24% 13.74% 2.50% 3.00% 3.50% 4.00% 4.50% 16.1 16.6 17.1 17.7 18.3 15.5 15.9 16.3 16.9 17.4 14.24% 14.9 15.2 15.6 16.1 16.6 14.74% 14.3 14.7 15.0 15.4 15.9 15.24% 13.8 14.1 14.5 14.8 15.2 Source: ADCB research 4
Using our peer-based multiples valuation, our regression analysis yields a fair value per share of AED 12.8. 3.5x Regression Analysis 3.0x 2.5x 2.0x P/B 1.5x 1.0x 0.5x 0.0x 4.0% 8.0% 12.0% 16.0% 20.0% 24.0% 28.0% ROE Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations Intercept X Variable 1 0.934 0.873 0.806 0.571 16 0.000 0.000 5
Income Statement Balance Sheet (AED mn) Q109A Q209E Q309E Q409E Q109A Q209E Q309E Q409E Interest Income 1,630 1,3533 1,252 1,213 Cash and due from Banks 4,167 5,884 6,862 7,832 Interest Expense 755 497 485 528 Investments 16,099 16,105 16,460 16,482 Net Interest Income 875 857 767 686 Advances 83,640 84,099 85,085 86,039 Fixed Assets (Net) 2,079 2,694 2,710 2,7277 Other Income 443 467 427 445 Other Assets 3,432 3,796 4,676 4,715 Total Net Income 1,319 1,3233 1,194 1,130 Total Assets 109,417 112,578 115,793 117,794 Operating Expense 293 309 326 343 Customer deposits 75,744 77,155 79,518 79,6666 Pre-Provisioning Profit 1,026 1,014 868 787 Borrowings 13,165 13,663 13,693 15,442 Provisions and Contingencies 275 248 158 203 Other Liabilities 3,456 3,940 4,053 4,123 Profir Before Tax 751 7677 710 584 Total Liabilities 92,365 94,759 97,264 99,231 Tax - - - - Share Capital 1,375 1,375 1,375 1,375 Minority Interest 0.61 0.61 0.61 0.61 Reserves and Surplus 15,678 16,444 17,154 17,1888 Net Profit 750 7666 709 584 Total Liabilities 109,417 112,578 115,793 117,794 Income Statement Key Ratios (AED mn, Yr. ending Dec. 31) FY07A FY08A FY09E FY10E FY07A FY08A FY09E FY10E Interest & Islamic Financing Income 3,603 4,957 5,449 5,204 Per share data (AED) Interest & Islamic Financing Expense 2,272 2,3777 2,264 2,592 Shares outstanding (mn) 1,250 1,375 1,375 1,375 Net Int. & Islamic Fin. Income 1,331 2,581 3,185 2,612 EPS 1.6 2.2 2.0 1.6 10.2% 93.8% 23.4% -18.0% Book value per share 8.1 9.2 10.3 11.4 Other Income 1,494 2,118 1,782 1,887 Total Net Income 2,826 4,698 4,966 4,500 Valuation ratios (x) 37.3% 66.3% 5.7% (9.4%) P/Pre-provisioning Profit 12.5x 3.2x 5.2x 6.5x Operating Expense 611 1,135 1,271 1,549 P/E 13.8x 3.8x 6.8x 8.9x Pre-Provisioning Profit 2,215 3,564 3,695 2,951 P/B 2.7x 0.9x 1.3x 1.2x Provisions 207 5666 884 813 Profit Before Tax 2,008 2,997 2,811 2,139 Performance ratio (%) Tax - - - - Return on average assets 3..3% 3.3% 2.5% 1.7% Minority Interest 0.02 (8.05) 2.44 4.87 Return on average net worth 21..7% 25.6% 16.3% 10.9% Net Profit 2,008 3,005 2,809 2,134 NIM 2..4% 3.1% 3.1% 2.4% Yield 6..7% 6.0% 5.3% 4.7% Balance Sheet Cost of funds 4..8% 3.9% 2.9% 3.1% Cash and balances 8,978 5,0055 5,521 4,173 Non interest Income (% growth) 75..9% 41.7% (15.9%) 5.9% Investments 13,359 14,5244 16,482 19,422 Non interest Income to total income 52..9% 45.1% 35.9% 41.9% Advances 48,594 82,2000 88,350 97,486 30.0% 69.2% 7.5% 10.3% Balance Sheet ratios (%) Fixed Assets (Net) 1,526 2,0122 2,727 2,803 Advances growth 76..5% 4.4% 8.4% 10.5% Other Assets 741 3,780 4,715 5,074 Deposits growth 51..8% 41.5% 7.7% 9.9% Total Assets 73,198 107,5222 117,794 128,959 Advances to deposit 85..0% 107.3% 108.0% 108.5% Investment properties (% of deposit) 5..6% 5.4% 5.0% 4.6% Customer Deposits 52,256 73,9633 79,666 87,589 Non-Trading Investment (% of deposit) 19..3% 13.5% 15.0% 17.0% 51.8% 41.5% 7.7% 9.9% Liquid assets (% of assets) 18..0% 7.3% 6.6% 5.1% Borrowings 8,571 16,698 15,442 16,842 Other Assets (% of deposit) 1..4% 3.2% 4.3% 4.3% 132.0% 94.8% -7.5% 9.1% Borrowings (% of advances) 19..3% 11.2% 6.5% 7.2% Other Liabilities 2,250 3,842 4,123 4,514 Capital Adequacy ratio 15..0% 14.1% 21.0% 20.1% Total Liabilities 63,077 94,502 99,231 108,945 Operating ratios (%) Share Capital 1,250 1,375 1,375 1,375 Operating cost to operaing income 21..6% 24.2% 25.6% 34.4% Reserves & Surplus / others 8,870 11,645 17,188 18,639 Operating cost to net income 30..4% 37.8% 45.2% 72.6% Total Equity & Liabilities 73,198 107,5222 117,794 128,959 Operating cost to avg. assets 0..6% 1.0% 1.0% 1.1% Source: ADCB research 6
Investment Ratings: Buy: More than 15% potential return. We recommend that investors buy the stock based on the annualised return to the shareholders over 6-24 months time horizon (percentage change from current price to the projected target price). Sell: Negative potential return. We recommend that investors sell the stock based on the annualised return to the shareholders over the 6-24 months time horizon. Hold: Between 0 and 15% potential return. We take a neutral view on the stock over the 6-24 months period. Other Disclosures: Abu Dhabi Commercial Bank (ADCB) publishes independent research based on its own opinions and does not have investment banking relationships with any firm whose security is mentioned in this report. ADCB does, however, hold securities of the firm mentioned in this report through its fund management activities. If you choose to use the information in this report, you do so on your own initiative, and you are responsible for compliance with any applicable local laws. ADCB certifies that no part of the research analyst s compensationn was, is, or will be, directly or indirectly, related to the specificc recommendations or view expressed in this research report. The information and opinions in this report were prepared by employees of ADCB and are current as of the date of the report. The information contained herein has been obtained from sources thatt they believee to be reliable, but ADCB does not guarantee its accuracy, adequacy, completeness, reliability, or timeliness. Moreover, it is not responsiblee for any errors or omissions or for the results obtained from the use of such information. All opinions and estimates included in this report are subject to change without notice. ADCB will furnish, upon request, available investmentt information supporting this recommendation. This report is intended for qualified customers of ADCB. This research report provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment or any options, futures or derivatives related to such securities or investments. It is not intendedd to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investorss should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospectss may not be realised. Investors should note that income from such securities or other investments, if any, may fluctuate and that price or value of such securities and investments may rise or fall. Accordingly, investors may receive back less than originally invested. Past performancee is not necessarily a guide to future performance. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. Foreign currency rates of 7
exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk. To the fullest extent permitted by law, neither ADCB nor any of its employees will be liable to you or anyone else under any tort, contract, negligence, strict liability, products liability, or other theory with respect to this presentation of information. You may not redistribute this report withoutt explicit permission from ADCB. 8
ADCB Research Team: Khaled Akl, MBA, CFA Head of Research Khaled.A2@adcb.com +971 2 696 2843 Sami Benghezal, M.Sc, FRM, CFA Research Manager sami.b2@adcb.com +9712 697 3525 Jehad Saeed Al Mazrooei Research Analyst Jehad.s@ @adcb.com +9712 697 3522 Rakesh Kumar Agrawal, MBA Research Analyst Rakesh..k@adcb.com +9712 697 3685 9