C O M P A N Y U P D A T E Monday, April 09, 2018 FBMKLCI: 1,837.01 Sector: Finance THIS REPORT IS STRICTLY FOR INTERNAL CIRCULATION ONLY* Hong Leong Bank Berhad TP: RM21.30 (+14.5%) Taking the Digital Leap Last Traded: RM18.60 BUY Li Hsia Wong Tel: +603-2167 9610 liwong@ta.com.my www.taonline.com.my We attended Hong Leong Bank s (HLBB) corporate day recently. In addition to presenting the bank s digital aspirations, management highlighted that some the other near term strategic priorities include leveraging branch footprint to build the best in class SME business, refitting banking halls for better space utilisation and enhance overseas contributions. Having embarked on a digital strategy roadmap earlier than most banks, we foresee the benefits to unfold via the capture of larger market share in areas such as transactional banking, cash management and CASA as well as cost savings through efficiency improvement and productivity gains. Tagging Hong Leong at a higher PBV of 1.7x, i.e. based on the stock s average 10-year rolling PBV, we raise TP to RM21.30. With that, we raise our recommendation from hold to BUY. Shifting from Traditional to Digital A leader with many firsts in terms of digital banking innovation, management noted that business momentum has gathered pace in both the retail and corporate segments. Mobile and online digital adoption among its customers have grown tremendously with some 72% of total transactions are via a digital platform vs. only 42% in FY15. With that, management noted that the use of SST and branch transactions have reduced significantly as many customers are adopting mobile and online digital for greater convenience. Forging Ahead on the Digital Frontier Some recent initiatives include the opening of its iconic branch in Damansara City where paperless banking and intuitive self-serve banking is introduced. Elsewhere in digital banking, HLBB is collaborating with other technology providers such as enabling WeChat Pay transactions in Malaysia and with Samsung Pay for its credit cards. We believe the launch of the Hong Leong Connect First, a new cash management system could improve transactions volumes, and with it higher CASA deposits, better fee income and reduce operational costs of branches. We believe that these initiatives have helped boost HLBB s CASA balances. In 4QCY17, we observe that HLBB registered strongest CASA growth of 9.3% YoY vs. its peers 6.1% increase. Share Information Bloomberg Code HLBK MK Stock Code 5819 Listing Main Market Share Cap (mn) 2045.6 Market Cap (RMmn) 38,048.2 52-wk Hi/Lo (RM) 20.02/13.52 12-mth Avg Daily Vol ('000 shrs) 1152.4 Estimated Free Float (%) 15.4 Beta 0.85 Major Shareholders (%) Hong Leong Financial - 65.7 EPF - 13.4 Forecast Revision FY18 FY19 Forecast Revision (%) 0.0 0.0 Net profit (RMmn) 2389.7 2594.8 Consensus 2532.0 2709.0 TA's / Consensus (%) 94.4 95.8 Financial Indicators FY18 FY19 ROE (%) 11.6 11.7 ROA (%) 1.2 1.3 CTI Ratio (%) 44.3 43.2 Gross Impaired Loans Ratio ( 1.0 0.9 LD Ratio (%) 81.4 82.2 BV/ Share (RM) 11.8 12.6 Price/ BV (x) 1.6 1.5 Share Performance (%) Price Change HLBK FBM KLCI 1 mth (1.1) (1.4) 3 mth 0.0 (1.7) 6 mth 16.7 5.1 12 mth 34.8 3.9 (12-Mth) Share Price relative to the FBMKLCI Cost Savings through Efficiency and Productivity Gains According to HLBB, the cost to serve corporate customers and payment processing have reduced by some 40% and 94% between Jan 2017 and Jan 2018 due to its digital initiatives. Boasting the second leanest cost structure among its listed peers, HLBB s cost-to-income ratio stood at around 42% in 4QCY17 vs. the sector s average of close to 50%. We see room for improvement as cost savings filter through to bottomline due to efficiency improvement and productivity gains. In the longer term, we also foresee opportunities in reducing operating costs via a rationalisation of bank branches and SST as the use of digital banking accelerates. We note that HLBB has the second highest branch network in the country. Source: Bloomberg Page 1 of 5
Figure 1: Branch network (as at Dec 2017) Source: Companies, TA Research Opportunities for Stronger Revenue Growth Management also shared that digitally engaged customers take up more products compared with customers engage via the traditional banking route. Additionally, HLBB shared that profitability per customer improves by some 16% for retail and from RM2.2k to RM14.6k for the corporate customers. We also see that the bank is set to establish a stronger footing in the Priority Banking and Private Banking space in Malaysia. We were given a brief tour of the new, sophisticated and very impressive Priority Banking and Private Banking suites, designed to meet the lifestyle of its affluent and ultra-affluent market. Steadier Margins Envisaged Attributed to Strong CASA Operationally, management predicts steadier net interest margin NIM in FY18 with the help of the OPR hike in January, which should help sustain margins above 2% comfortably. While we do expect overall competition for deposits to remain rather intense, we believe HLBB s new cash management system could help draw CASA. Stronger CASA balances could help keep a lid on rising COF, as term deposits would be re-priced in the event of another rate hike. We also foresee opportunities in on boarding of payroll accounts, opening doors in providing financial services to a larger pool of SME customers. Figure 2: Net interest margin (%) Source: Companies, TA Research Page 2 of 5
Stronger Commercial and SME Loans in the 2HFY18 HLBB s loan growth has been rather subdued, rising less than its peers and BNM s loan growth in the recent results announcement. Nevertheless, management expects momentum to improve post the general election as some businesses probably held back loan raising activities due to increased volatilities and macro uncertainties. The pipeline of SME loans along with acceptance have also ballooned in the past 3 quarters, thanks to the launch of several digital initiatives. This, we believe could lead to further drawdowns in the SME segment in 2HFY18. Fuelling better loan growth prospects for HLBB is the strengthening business optimism among Malaysian companies, which according to D&B Malaysia Index (BOI) has hit a new peak in 1Q18. Taken together, we forecast stronger loan growth of 4/5/6% for FY18/19/20 vs. an increase of 1.8% YoY (or +0.3% YTD) in 2QFY18. Figure 3: Loan growth (YoY Chg) Source: Company, Bank Negara Malaysia, TA Research Consumer loans to remain on a cautious mode Mortgages account for 46% of HLBB s total loans and advances. Decent pipeline of mortgage loans coupled with approval rates in excess of 75% could help support its mortgage book. However, booking of new mortgage loans could soften as consumer sentiments is expected to remain lacklustre in 2018. Highlighting excerpts from a recent 11th Malaysian Property Summit, the property market is expected to remain soft this CY. While the affordable housing market should to remain active, we believe that the mid to high-end market, or HLBB s target market, could remain sluggish. Stronger growth from China Contribution from China associates have been giving an added boost to HLBB s PBT. In 2Q, Bank of Chengdu profit contribution surged by almost 60% YoY and accounted for 18% (up from 10% in 1HFY17) of group s PBT. Management noted that the recovery in China s would continue to be underpinned by improving asset quality and healthier topline growth. Surpassing expectations, we raised our growth assumptions for BOCD post the release of HLBB s 2Q results. Share Price Increased from Strength to strength HLBB s share price performance has surged ahead of the KLCI in the past 3-12 months. Driving the solid increase in the share price, foreigners holding shares Page 3 of 5
in the company have risen substantially since 2017 from c. 9% to 12.5% in March 2018. Operationally, HLBB s earnings growth has been encouraging due to stronger operating income, improved contributions from its China associates and healthy asset quality. Trading at a premium to its peers, we believe HLBB s valuations get an added boost from decent average ROEs of around 10% vs. its peers ROE of some 9% (excl. Public Bank). Figure 4: Foreign shareholding level (%) 13.00% 12.00% 11.00% 10.00% 9.00% 8.00% 7.00% 6.00% Mar-13 Jun-13 Sep-13 Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Source: Company, TA Research Valuation and recommendation We make no change to our earnings estimates. At current share price, the stock continues to trade at a premium to the industry s and mid-cap peers average of 1.2x and 1.0x respectively. However, we believe the premium is justified due to HLBB s higher-than-average ROE, robust asset quality and lean cost structure, which we envisage should improve as more digital initiatives are rolled out. Tagging Hong Leong at a higher PBV of 1.7x, i.e. based on the stock s average 10-year rolling PBV, we raise TP to RM21.30. With that, we raise our recommendation from hold to BUY. We believe other earnings catalysts include a stronger pickup in loans in the upcoming results, sustainable recovery in other overseas contributions (excl. BOCD), rising CASA balances to help cushion rising COF and sustainable increase in foreign inflows and readiness of customers and NTB customers to adopt HLBB s digital initiatives and capture market shares. Page 4 of 5
Table 1: Financial Summary (RMmn) Profit & Loss (RM mn) Key Financial Ratios FYE 30 June 2016 2017 2018E 2019E 2020E FYE 30 June 2016 2017 2018E 2019E 2020E Interest income 6,303.5 6,163.1 6,415.4 6,791.5 7,151.7 Return and efficiency Interest expense (3,648.4) (3,308.7) (3,506.6) (3,669.9) (3,953.5) ROE (%) 10.0% 9.8% 10.2% 10.4% 10.4% Net interest income 2,655.1 2,854.4 2,908.8 3,121.6 3,198.2 ROA (%) 1.0% 1.1% 1.2% 1.3% 1.3% Islamic banking income 467.5 550.1 616.1 677.7 745.5 Fee-based/total income (%) 14.8% 13.4% 13.1% 12.4% 12.1% Total non-interest income 1,055.3 1,146.1 1,218.4 1,297.7 1,384.9 Non-interest/total income (%) 25.3% 25.2% 25.7% 25.5% 26.0% Total income 4,177.9 4,550.6 4,743.2 5,097.0 5,328.6 Cost-to-income (%) 49.9% 44.1% 44.3% 43.2% 43.3% Overhead expenses (2,086.8) (2,007.5) (2,100.5) (2,200.4) (2,307.7) Operating profit 2,091.1 2,543.1 2,642.7 2,896.6 3,020.9 Balance sheet Total loan loss provisions (42.8) (158.9) (147.1) (242.9) (233.7) Loans growth (%) 6.3% 3.8% 4.0% 5.0% 6.0% Share of PAT of equity accounted 333.4 364.1 491.5 589.8 648.8 Gross Impaired Loans ratio (%) 0.8% 1.0% 1.0% 0.9% 1.0% Profit before tax 2,381.7 2,748.3 2,987.1 3,243.4 3,435.9 Loan loss coverage (%) 120.9% 120.8% 119.9% 114.5% 132.9% Taxation (478.3) (603.2) (597.4) (648.7) (687.2) Deposit growth (%) 5.9% 4.5% 3.0% 4.0% 5.0% Net profit 1,903.4 2,145.0 2,389.7 2,594.8 2,748.7 LD ratio (%) 81.2% 80.6% 81.4% 82.2% 83.0% CET1 Ratio (%) 13.2% 13.8% 14.3% 14.7% 15.3% Balance Sheet (RM mn) Total Capital Ratio (%) 15.1% 16.3% 16.7% 17.0% 17.4% FYE 30 June 2016 2017 2018E 2019E 2020E Cash and short-term funds 7,474.0 10,823.3 11,081.8 11,262.6 12,302.9 Investment statistics Deposit with FIs 2,057.4 826.7 744.1 669.7 602.7 PER (x) 20.0 17.7 15.9 14.7 13.8 Marketable securities 47,022.1 46,703.9 49,027.0 51,466.2 54,027.3 PBT growth rate (%) -13.3% 15.4% 8.7% 8.6% 5.9% Total current assets 56,553.4 58,353.9 60,852.9 63,398.5 66,932.8 EPS (sen) 93.0 104.9 116.8 126.8 134.4 Net loans and advances 119,458.1 123,990.9 128,709.3 135,126.5 143,212.4 EPS growth rate (%) -14.8% 12.7% 11.4% 8.6% 5.9% Fixed assets 1,382.5 1,423.1 1,423.1 1,423.1 1,423.1 BV per share (RM) 10.31 11.09 11.79 12.55 13.36 Other long-term assets 2,719.5 2,365.6 2,483.7 2,607.6 2,737.7 P/BV (x) 1.80 1.68 1.58 1.48 1.39 Goodwill and Intangibles 2,096.1 2,044.6 2,044.6 2,044.6 2,044.6 DPS (sen) 41.0 45.0 48.0 48.0 48.0 Investment in associates 3,322.6 3,636.1 3,745.2 3,857.5 3,973.2 Dividend yield (%) 2.2 2.4 2.6 2.6 2.6 Statutory deposits 4,296.1 3,738.2 3,135.9 3,275.7 3,441.4 Total assets 189,828.2 195,552.5 202,394.6 211,733.6 223,765.3 Customer deposits 148,523.9 155,233.2 159,890.2 166,285.8 174,600.1 Deposits from other FIs 6,201.2 5,486.7 5,761.0 6,221.9 6,844.1 Bills and acceptances 350.5 364.7 382.9 421.2 484.4 Borrowings 4,523.2 2,917.8 2,933.2 2,949.2 2,965.6 Other liabilities 9,112.3 8,864.8 9,308.0 10,179.4 11,545.9 Total liabilities 168,711.1 172,867.1 178,275.4 186,057.5 196,440.0 Shareholders' funds 21,117.1 22,685.4 24,119.2 25,676.1 27,325.3 Stock Recommendation Guideline BUY : Total return within the next 12 months exceeds required rate of return by 5%-point. HOLD : Total return within the next 12 months exceeds required rate of return by between 0-5%-point. SELL : Total return is lower than the required rate of return. Not Rated: The company is not under coverage. The report is for information only. Total Return is defined as expected share price appreciation plus gross dividend over the next 12 months. Gross dividend is excluded from total return if dividend discount model valuation is used to avoid double counting. Required Rate of Return of 7% is defined as the yield for one-year Malaysian government treasury plus assumed equity risk premium. Disclaimer The information in this report has been obtained from sources believed to be reliable. Its accuracy and/ 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. As of Monday, April 09, 2018, the analyst, Wong Li Hsia, who prepared this report, has interest in the following securities covered in this report: (a) nil Kaladher Govindan Head of Research TA SECURITIES HOLDINGS BERHAD (14948-M) A Participating Organisation of Bursa Malaysia Securities Berhad Menara TA One 22 Jalan P. Ramlee 50250 Kuala Lumpur Malaysia Tel: 603 2072 1277 Fax: 603 2032 5048 www.ta.com.my Page 5 of 5