Pricing in tougher times Equity Research General Update March 22nd, 2009 SABB (1060.SE) Current price SAR 42.9 Country Saudi Arabia Fair value target SAR 41.2 Sector Commercial banking Recommendation NEUTRAL Exchange Saudi Stock Exchange (Tadawul) Sector Coverage Team Sofia El Boury +9714 4283 533 selboury@shuaacapital.com Ghida Obeid +9714 4283 536 gobeid@shuaacapital.com Mahdi H. Mattar, Ph.D. +9714 3199 839 mmattar@shuaacapital.com Samba Financial Group (1090.SE) Current price SAR 40.0 Country Saudi Arabia Fair value target SAR 48.6 Sector Commercial banking Recommendation BUY Exchange Saudi Stock Exchange (Tadawul) Despite strong YoY balance sheet growth, Saudi banks' profitability declined 14.2% in 2008 as they continued to suffer from sluggish market-related revenues and interest spread contraction. This was further aggravated by the rise in provisioning and sizeable mark-to-market (MTM) investment losses. Although the Saudi banking system remains a regional favourite, owed to a strong regulatory framework and historically conservative prudential guidelines, soundness of local banks' operating environment is being tested as the global financial system parameters are changing. In a regional climate marked by economic slowdown, liquidity tightness and expected deterioration in asset quality, we are revising our forecasts on SABB and Samba taking into account the forthcoming economic challenges. During 2008, SABB's business model proved resilient to the banking sector's difficulties. The bank continued to outperform local peers in terms of balance sheet growth while displaying a low risk profile as evident through its strong asset quality indicators and large exposure to government securities. Despite obvious strengths and a stock price outperforming the local benchmark (SABB is only down 0.7% year-to-date vs. -12.6% for SC Saudi Arabia), we downgrade our recommendation on SABB from BUY to NEUTRAL as its fair value per share of SAR 41.2 presents a 4.0% downside to the current share price of SAR 42.9, and as its low 2008 capital adequacy ratio (CAR) compared to local peers is detrimental to its valuation. Samba Financial Group (Samba), or what we had previously named the Holding Fort, has once again showed notable cautiousness in terms of lending activity in 2008 while significantly de-risking its large investment portfolio during the year. Not immune to MTM investment losses and margin contraction, the bank's bottom line was down 7% YoY in 2008 while its stock price significantly underperformed the benchmark index since the beginning of 2009. We update coverage on SAMBA by reiterating our BUY recommendation based on a target price of SAR 48.6, representing a 21.5% upside to the current price of SAR 40.0.
Contents SABB (1060.SE)...3 INVESTMENT THESIS... 4 ANALYSIS AND REVISED FORECASTS... 6 VALUATION... 10 FINANCIALS... 11 SAMBA FINANCIAL GROUP (1090.SE)...13 INVESTMENT THESIS... 14 ANALYSIS AND REVISED FORECASTS... 16 VALUATION... 20 FINANCIALS... 21 APPENDIX: SAUDI BANKING SECTOR OVERVIEW...23 March 22nd, 2009 2
SABB (1060.SE) On a cautious growth path Equity Research General Update March 22nd, 2009 Current price SAR 42.9 Country Saudi Arabia Fair value target SAR 41.2 Sector Commercial banking Recommendation NEUTRAL Exchange Saudi Stock Exchange (Tadawul) Sector Coverage Team Sofia El Boury +9714 4283 533 selboury@shuaacapital.com Ghida Obeid +9714 4283 536 gobeid@shuaacapital.com Mahdi H. Mattar, Ph.D. +9714 3199 839 mmattar@shuaacapital.com In 2008, SABB delivered stronger than average bottom line growth with net profit up 12% YoY to SAR 2.9bn. The bank, however, missed our FY forecast mainly on the back of lower than anticipated assets growth and mark-to-market investment losses, despite the strong performance of trade-related and corporate finance fee business. The bank's ability to offset volatility of market-driven revenues will, in our view, steer top line revenues growth moving forward despite obvious challenges, especially in terms of liquidity. Although we acknowledge the bank's conservative risk management policies and the strong support provided for by its parent company, we however revise our forecast downward taking into account the global and regional economic slowdown in the medium term. Although we consider SABB as one of the strongest banking franchises in Saudi Arabia, we can not ignore the low CAR compared to local peers, which calls for caution in terms of risk-taking and cash distribution. We have downgraded our recommendation on SABB from BUY to NEUTRAL as its fair value per share of SAR 41.2 presents a 4.0% downside to the current share price of SAR 42.9. Year Net profit (SAR' 000) BV (SAR' 000) EPS (SAR) BVPS (SAR) Dec-11E 3,977,025 18,356,435 5.30 24.48 23.0 8.1 1.8 Dec-10E 3,561,736 16,157,536 4.75 21.54 23.6 9.0 2.0 Dec-09E 3,147,527 14,008,003 4.20 18.68 24.5 10.2 2.3 Dec-08 2,920,019 11,633,831 3.89 15.51 27.6 11.0 2.8 RoAE (%) P/E (x) P/BV (x) 52-week range (SAR) 36.4-93.6 Number of shares ('000) 750,000 Free Float (%) 39 Market cap (SAR '000) 32,175,000 Market cap (USD '000) 8,672,507 Dividend Yield 2008 (%) 2.2
Investment thesis Despite falling short of our estimates, SABB was one of the top performing banks in Saudi Arabia in terms of bottom line growth in 2008 with net profit up 12% YoY (against an average decline of 14.2% for local banks). Top line revenues' growth was sustained by a strong uptake in trade and corporate finance related fees and trading income, which offset the decline in margins and mark-to-market investment losses during the year. By the end of the period, SABB came out as an outperformer in terms of balance sheet expansion while still enjoying the best asset quality indicators of the industry, with a robust technical and operational support from its parent company, HSBC. Although we consider SABB as one of the strongest banking franchises in Saudi Arabia, we can not ignore the low CAR compared to local peers, which calls for caution in terms of risk-taking and cash distribution. We however revise our forecast downward taking into account the global and regional economic slowdown in the medium term. As a result, we have downgraded our recommendation for SABB from BUY to NEUTRAL as our fair value target of SAR 41.2 presents 4.0% downside to the current price of SAR 42.9 per share. Lowering our earnings' estimates Given the recent developments in the Saudi banking industry and as highlighted in our Saudi banking sector overview section (Appendix), we have conservatively assumed a 8.3% sector deposits CAGR over 2008-2013, matched by a slower 6.6% loans growth over the same period. As a result, this would decrease the sector's Loans to Deposits Ratio (LDR) from 87% in 2008 to 80% by 2013. Moving forward, we believe SABB will continue to focus on organic growth and record above average assets expansion, supported by improving local penetration, robust asset quality indicators and the operational and technical back-up of an international banking franchise. Strong cross selling capabilities and the bank's ability to offset volatility of market-driven revenues will, in our view, steer top line revenues growth despite obvious challenges, especially in terms of liquidity. All in all, we expect SABB's deposit base to grow by a CAGR of 10.2% over 2008-2013 period, while loans will expand at an annual pace of 9.0% over the same period. In terms of revenues, operating income and net profit will increase at respective 2008-2013 CAGR of 10.9% and 10.4%. Valuation Approach Our fair value target of SAR 41.2 per share is derived from two different methods: a DECF valuation (70% weight) and a peer valuation (30% weight). We have significantly decreased our fair value target for SABB from SAR 77.8 (adjusted to the latest bonus share issue) to SAR 41.2, as our revised forecasts for the bank incorporate (i) expected slow-down in loan origination, (ii) contraction of net interest spreads mainly as a result of rising funding costs, (iii) increase in NPLs and (iv) a low capitalization ratio compared to local peers. In addition to this, we have amended our valuation parameters in order to reflect higher risks for the industry, translating into an increase in the cost of equity to 11.2% up from 8.7% in our previous assessment, and a decline in perpetual growth from a high 4.5% to 2.5%. As shown below, downward revision of our earnings estimates led to a SAR 42.4 per share cut of our previous DECF fair value target (of SAR 104.9), while change of valuation parameters translated into a SAR 17.6 downgrade. March 22nd, 2009 4
New vs. Old DECF Fair Value Target 104.9 42.4 17.6 44.9 0 Previous DECF FVT Source: SHUAA Capital Revised forecasts Revised valuation parameters New DECF FVT Our second valuation method is based on a regression of 2009E P/B multiple of a peer group of 19 GCC conventional banks against 2009e RoAE. Based on the derived regression equation, relative valuation of SABB resulted in a value per share of SAR 32.6. March 22nd, 2009 5
Analysis and revised forecasts Still an outperformer SABB's deposit base grew by a CAGR of 24% over the past three years (2005-2008), outperforming the industry's average growth over the same period. In FY 08, SABB's customer deposits recorded their historical strongest YoY increase at 29% (vs. 23% for the sector), reaching SAR 92.7bn, increasing the bank's market share to 10.1% (vs. 9.6% in FY 07). However, this strong increase in customer deposits came 11% below our previous annual estimate of SAR 104mn. This deviation from our previous forecast is a direct reflection of slowdown in fund-raising experienced by the local banking industry in H2 08 as a result of falling oil prices, economic slowdown and local liquidity shortage. Indeed, after jumping 13.5% in Q2 08, SABB's customer deposits slowed down to 7.5% in Q3 before retreating to 3.5% in the last quarter as term deposits matured. In order to cope with these unexpected client accounts movements, the bank has put in place a number of contingency plans. Bidding up for selective corporate funds is one of them, which could exercise some pressure on the bank's deposit costs especially given that corporate funds constitute the bulk of SABB's deposit base. This justifies the bank's ambition to capture more retail deposits as (i) they prove less volatile and stickier than other deposit categories and (ii) would contribute in bringing down overall customer deposits' costs. Furthermore, to serve this objective, SABB is planning to add 10 additional branches to the bank's current distribution network (of 68 branches) in the medium term. While we are concerned about Saudi banks' ability to attract deposits in this tight liquidity environment, we believe SABB has developed a strong capacity in growing its deposit base faster than the sector average. Given our 8.3% 2008-2013 CAGR forecast for the industry's deposits' growth, we believe SABB will increase customer deposits by 13.6% in 2009, and at a CAGR of 9.4% over 2009-2013. As shown below, these new figures are significantly below our previous (pre-crisis) forecasts by 16.6% on average over the 2009-2013 period. Although these forecasts might look conservative, we are retaining this outlook until more clarity arises regarding availability of liquidity on the regional scale. Customer deposits (SAR mn) 2009e 2010e 2011e 2012e 2013e Old 124,158 143,822 159,564 168,276 175,343 New 105,299 117,589 129,353 140,443 150,764 New vs. Old -15.2% -18.2% -18.9% -16.5% -14.0% Source: SHUAA Capital estimates Other funding sources The second major funding source for SABB is interbank liabilities. They almost doubled YoY from SAR 8.0bn in FY 07 to SAR 16.1bn in FY 08 as deposit-raising capabilities were constrained by the regional liquidity shortage. Highly volatile, these interbank liabilities will continue to act as a buffer not only to fill in liquidity needs but most of all to relax asset/ liability maturity mismatch whose persistence (due to a general loss of appetite in placing long term deposits) is highly threatening to the financing of major development projects. During Q3 2008, SABB was able to raise SAR 1,705mn through a 5-year SAR-denominated floating rate note (FRN) at an appealing rate of SIBOR +80bps. Moving forward, we conservatively assumed no further debt issuances will be performed by the bank. This stance is supported, at least in the short term, by the shut down of debt capital markets, as a result of the ongoing financial crisis. Should the bank have access to additional funding, this would constitute a notable upside to our valuation. March 22nd, 2009 6
Cautious lending Mainly driven by the momentum in financing of development projects boosted by oilrelated liquidity, SABB's loans and advances expanded by 29.4% in FY 08 to SAR 80.2bn, maintaining the bank's market share at 12.2%. This figure stood below our bullish initial expectation of SAR 91.1bn as the loan book slid by 4.0% QoQ (or SAR 3.4bn) in Q4 08. We have revised downwards our loan book growth projections for the next five years, in order to reflect the slowdown in project financing as well as consumer spending in Saudi Arabia. In our view, SABB's loan portfolio will expand by 12.4% in 2009, and at a CAGR of 8.2% over 2009-2013. Loans (SAR mn) 2009e 2010e 2011e 2012e 2013e Old 109,509 127,854 142,762 150,546 154,828 New 90,179 99,617 108,398 116,421 123,626 New vs. Old -17.7% -22.1% -24.1% -22.7% -20.2% Source: SHUAA Capital estimates Given historical compliance of the bank to a stringent lending discipline, we lower our loans (including term loans) to deposits ratio forecasts to an average of 82.0% over 2009-2013 vs. 84.2% previously. Loans to deposits ratio 2009e 2010e 2011e 2012e 2013e Old 83.5% 84.0% 84.5% 84.5% 84.5% New 81.3% 82.3% 82.7% 81.9% 82.0% New vs. Old (in bps) -223-167 -185-265 -255 Source: SHUAA Capital estimates. SABB's asset quality remained one of the strongest in the industry as NPLs only represented 0.24% of the gross loan book in FY 08 vs. 0.31% in FY 07. In 2009, we expect NPLs to significantly increase by 154% to reflect higher probabilities of default, with NPLs/ Gross Loans remaining at a low 0.5%. Over 2009-2013 period, we raise this ratio to an average of 0.7% vs. 0.3% previously. This slight upward revision reflects (1) the high proportion of corporate loans in the bank's book, and (2) the robust present/future asset quality of SABB ensured by the strict operational and credit risk management policies. NPLs/ Gross Loans 2009e 2010e 2011e 2012e 2013e Old 0.3% 0.3% 0.3% 0.3% 0.3% New 0.5% 0.6% 0.7% 0.7% 0.7% Provision cover Old 249% 254% 263% 279% 294% New 197% 214% 226% 266% 306% Source: SHUAA Capital estimates. March 22nd, 2009 7
NPLs and NPLs/ Gross loans ratio 900 815 878 935 1.0% 700 646 500 492 0.5% 300 194 100 2008 2009e 2010e 2011e 2012e 2013e NPLs (in SAR mn) NPLs/ Gross loans Source: SHUAA Capital estimates 0.0% As a result, we expect SABB to incur higher provision expenses moving forward, after cost of risk (provision expenses/ net loans) was limited to less than 0.5% in FY 08. We have slightly raised provision charges to an average of 0.8% over our forecast period, as the current over-provisioning policy of SABB is already providing a strong cushion for future losses. Accordingly, provision coverage will relax from a high 325% in FY 08 to 197% in 2009 before going back to SABB's historical high levels by 2013. SABB's investment portfolio almost doubled from SAR 14.9bn in FY 07 to SAR 29.6bn in FY 08, reflecting an accumulation of liquidity surplus during that period, cautiously allocated to the purchase of government securities at appealing yields. Moving forward, we maintain this pattern in which excess cash is channelled to attractive yet safe investments. Although we believe SABB's large exposure to AFS investments relative to peers is a material risk to its equity in case of impairment, we are however reassured by the fact that 90% of its FY 08 investment portfolio was composed of low-risk government or semigovernment instruments. Moving forward, the bank's treasury management will closely rely on this risk/ return allocation designed to ensure a maximum leverage of its balance sheet structure. Top line revenues under pressure SABB's net special commission income only expanded by 4.9% YoY in FY 08 to SAR 3.2bn, below our SAR 3.6bn estimate as we had bet on a more aggressive assets' growth with net interest spread inline with our expectation at 3.4% (down from 4.4% in 2007). Moving forward, we believe repricing of a portion of the bank's loan portfolio will provide support to net interest spread, although a downward pressure will come from expected higher funding costs (despite ongoing decrease of SIBOR). Consequently, we expect net interest spread to average 3.0% over 2009-2013. Similarly, net interest margin will hover around 3.1% over our forecast period. One of the major contributors to SABB's operating performance in 2008 was the fee and commission revenue line as it jumped by 45.9% YoY to reach SAR 1.26bn, yet standing slightly below our initial expectation of SAR 1.34bn due to the decline in market-driven revenues. In fact, the net improvement in the fee-generating income stream mainly reflected the momentum in trade finance and corporate finance and advisory activities, offsetting slump in brokerage and asset management revenues during the year. As we forecast a recovery in traded values on Tadawul towards the end of this year, we expect the overall fee revenue line to remain almost flat YoY in 2009, before expanding 11.7% annually over 2009-2013. Its contribution will remain between 22%-24% of operating income over our forecast period. With no significant downside expected on other non interest revenue streams, we expect operating income to curtail its growth to 10.9% over the 2008-2013 period. March 22nd, 2009 8
Operating expenses G&A expenses rose 14.9% YoY from SAR 1.4bn to SAR 1.6bn in FY 08, mainly as a result of the opening of five branches during the year as well as investments in the IT platform in order to enhance efficiency of alternative delivery channels. As a result, cost to income ratio went up from 32.7% in 2007 to 33.4% in 2008. Although the bank announced plans to add 10 branches to its current network in the medium term, we believe costs will somewhat remain under control and matched by a stronger growth in operating income, ultimately translating into a cost to income ratio hovering between 31%-33% over our forecast period. Returns and capital adequacy SABB's net profit went up from SAR 2.6bn in FY 07 to SAR 2.9bn in FY 08, a 12% YoY increase, outperforming local banks whose aggregated earnings fell 14.2% for the year. As a result of our revised forecasts we believe SABB will limit earnings growth to 7.8% in 2009, translating into a 24.5% RoAE. Over the remaining period, SABB should capitalize on a moderate balance sheet growth, strength of its trade and corporate finance related fee businesses and strong loan quality to record a 11.1% CAGR in net earnings over 2009-2013, with RoAE declining to 21.7% by 2013. One area of concern remains the low Tier 1 capital adequacy ratio of 8.3% reported by the bank at the end of 2008, with total CAR at 11.2%, one of the lowest amongst local peers when strength of banks' capital basis is key to ensuring their resilience to upcoming challenges as well as to providing capacity to grow further. As a result, the bank has recently decided the distribution of 1/4 bonus shares and refrained from proposing dividend for H2 08 period, reflecting cautiousness in terms of capital distribution. 4,500 4,000 3,500 3,000 Returns 2,920 3,148 3,562 3,977 4,385 4,792 28% 23% 2,500 2,000 1,500 2008 2009e 2010e 2011e 2012e 2013e Net profit (SAR mn) ROAE Source: SHUAA Capital estimates 18% March 22nd, 2009 9
Valuation Our fair value target of SAR 41.2 per share is derived from two different methods: a DECF valuation (70% weight) and a peer valuation (30% weight). Value per share (SAR) Weighting DECF 44.9 70% Relative valuation 32.6 30% Fair value 41.2 Our DECF for SABB resulted in a fair value target of SAR 44.9 per share. It was based on a five year cash flow forecast period and a fading period of 25 years during which the RoAE approaches cost of equity at 11.8%. Free cash flows were calculated by deducting the retentions required from projected net income to maintain a tier 1 capital ratio of at least 10%. In addition and in order to reflect overcapitalization and overprovisioning of the bank, we also incorporated PV of excess capital and PV of excess provisioning in the terminal value. In addition to this, we have amended our valuation parameters in order to reflect higher risks for the industry, translating into an increase in the cost of equity to 11.2% up from 8.7% in our previous assessment. In addition, perpetual growth rate was lowered to 2.5% from a high 4.5% previously. OLD NEW Risk free rate 4.7% 6.0% Market risk premium 5.0% 5.0% Beta 0.80 1.04 Cost of equity 8.7% 11.2% As a result, revision of our earnings estimates led to a SAR 42.4 per share cut of our previous DECF fair value target, while change of our valuation parameters translated into a SAR 17.6 downgrade. Our second valuation method is based on a regression of 2009e P/B multiple of a peer group of 19 GCC conventional banks against 2009e RoAE. Based on the derived regression equation, relative valuation of SABB resulted in a value per share of SAR 32.6. March 22nd, 2009 10
Financials SABB Balance Sheet - SAR '000 Year to December 2008 2009E 2010E 2011E 2012E 2013E Cash & Balances with SAMA 11,328,253 13,166,591 14,007,425 14,631,799 15,708,301 15,926,361 Due from Banks 6,200,466 7,044,874 7,867,153 8,654,165 9,396,171 10,086,650 Investments, net 29,604,346 34,753,652 38,431,852 42,925,360 48,719,284 53,811,983 Loans & advances 80,236,757 90,178,968 99,616,808 108,398,484 116,421,158 123,626,329 Investments in an associate 148,356 258,507 368,658 478,809 588,960 699,111 Property and equipment, net 561,460 572,689 584,143 595,826 607,742 619,897 Other assets 3,581,055 4,043,867 4,424,236 4,805,282 5,211,968 5,537,131 Total assets 131,660,693 150,019,148 165,300,276 180,489,725 196,653,585 210,307,463 Customer deposits 92,677,537 105,298,790 117,589,285 129,352,653 140,443,310 150,763,816 Due to banks 16,069,492 18,257,909 20,388,976 22,428,643 24,351,668 26,141,156 Debt securities in issue 5,656,800 5,656,800 3,406,800 1,796,961 1,796,961 91,961 Borrowings 187,500 187,500 187,500 187,500 187,500 187,500 Other liabilities 5,435,533 6,138,016 6,715,363 7,293,736 7,911,027 8,404,579 Total liabilities 120,026,862 135,539,016 148,287,923 161,059,494 174,690,467 185,589,011 Total shareholders' equity 11,633,831 14,008,003 16,157,536 18,356,435 20,779,058 23,424,574 Proposed dividends 0 472,129 854,817 1,073,797 1,184,059 1,293,878 Total liabilities and equity 131,660,693 150,019,148 165,300,276 180,489,725 196,653,585 210,307,463 SABB Income Statement - SAR '000 Year to December 2008 2009E 2010E 2011E 2012E 2013E Special commission income 5,864,966 7,469,299 8,448,757 9,327,313 10,165,197 10,960,421 Special commission expense -2,657,922-3,651,607-4,175,252-4,609,783-4,993,712-5,361,814 Net special commission income 3,207,044 3,817,692 4,273,506 4,717,531 5,171,486 5,598,608 Net fee and commission income 1,257,222 1,246,413 1,418,245 1,574,186 1,746,010 1,941,462 Net gains from FX transactions 138,310 152,141 164,312 172,528 181,154 190,212 Trading income 363,569 399,926 431,920 453,516 476,192 500,001 Dividends income 1,770 1,770 1,770 1,770 1,770 1,770 Income on investments held at FVIS -42,400 6,509 7,396 11,722 12,895 14,000 Gains on non trading investment -17,010-13,527-12,491-11,535-10,652-9,837 Other income 3,023 3,174 3,333 3,500 3,674 3,858 Total non-interest income 1,704,484 1,796,406 2,014,485 2,205,687 2,411,043 2,641,467 Total income from operations 4,911,528 5,614,099 6,287,991 6,923,217 7,582,528 8,240,075 Staff and general expenses -898,078-1,066,679-1,226,158-1,384,643-1,554,418-1,730,416 Depreciation -107,395-109,406-111,594-113,826-116,103-118,425 Rent and premises related expenses -79,459-80,947-82,566-84,217-85,902-87,620 Provision for credit losses -371,280-690,025-802,088-883,635-949,034-1,007,769 Impairment of financial assets -86,929-62,552-35,546 - - - Other G&A expenses -556,612-567,036-578,377-589,944-601,743-613,778 Other expenses -77-77 -77-77 -77-77 Total non-special commission expenses -2,099,830-2,576,722-2,836,406-3,056,343-3,307,277-3,558,084 Profit before tax 2,811,698 3,037,376 3,451,585 3,866,874 4,275,252 4,681,991 Share in earning of an associate 108,321 110,151 110,151 110,151 110,151 110,151 Net profit 2,920,019 3,147,527 3,561,736 3,977,025 4,385,403 4,792,142 March 22nd, 2009 11
SABB - Key ratios - %, unless otherwise stated Year to December 2008 2009E 2010E 2011E 2012E 2013E Growth Equity 22.0 20.4 15.3 13.6 13.2 12.7 Assets 34.1 13.9 10.2 9.2 9.0 6.9 Loans 29.4 12.4 10.5 8.8 7.4 6.2 Deposits 29.0 13.6 11.7 10.0 8.6 7.3 Net special commission income 4.9 19.0 11.9 10.4 9.6 8.3 Operating income 12.3 14.3 12.0 10.1 9.5 8.7 Net profit 12.0 7.8 13.2 11.7 10.3 9.3 Capital Adequacy Tier 1 capital 8.3 8.1 8.4 8.7 9.1 9.6 Equity / assets 8.8 9.3 9.8 10.2 10.6 11.1 Asset Quality NPL / Gross Loans 0.2 0.5 0.6 0.7 0.7 0.7 LLP / NPL 325 197 214 226 266 306 Margins and Profitability Interest Spread 3.4 3.1 3.0 3.0 3.0 3.0 Net interest Margin 3.3 3.1 3.1 3.1 3.1 3.1 Net Profit Margin 38.6 34.0 34.0 34.5 34.9 35.2 RoAE 27.6 24.5 23.6 23.0 22.4 21.7 RoAA 2.5 2.2 2.3 2.3 2.3 2.4 Liquidity Loans / Interest Earning Assets 69.4 68.6 68.7 68.2 67.1 66.3 Loans / Deposits + term loans 81.6 81.3 82.3 82.7 81.8 82.0 Efficiency Cost/income 33 32 32 31 31 31 March 22nd, 2009 12
Samba Financial Group (1090.SE) On stand-by for full capacity Equity Research General Update March 22nd, 2009 Current price SAR 40.0 Country Saudi Arabia Fair value target SAR 49.6 Sector Commercial banking Recommendation BUY Exchange Saudi Stock Exchange (Tadawul) Sector Coverage Team Sofia El Boury +9714 4283 533 selboury@shuaacapital.com Ghida Obeid +9714 4283 536 gobeid@shuaacapital.com Mahdi H. Mattar, Ph.D. +9714 3199 839 mmattar@shuaacapital.com Samba's 2008 full year profit fell to SAR 4.5bn implying a 7.8% YoY decline (compared to a an average decline of 14.2% for local banks). 2008 operating revenues slightly lingered by 2.6% YoY to SAR 7.0bn on the back of tightening spreads, mark-to-market losses on investments, and weak capital market activities. However, and despite times of tightening liquidity, Samba distinguished itself as one of the most liquid local franchises and undoubtedly the most efficient given its highest loan and deposit volumes per branch. Going forward, we believe Samba's balance sheet is still apt for growth yet at lower rate than 2008. The bank's strategy will continue to serve loan book expansion yet maintaining caution and enhancing book quality while reinforcing its deposit base. In addition to that, the bank will continue de-risking its investment portfolio by concentrating on local government treasuries to aid reduce mark-to-market losses and insure a sustainable alternative source of income. We are reiterating our BUY recommendation on Samba based on a revised fair value target of SAR 48.6 defining a 21.5% upside to the current share price of SAR 40.0. The revised fair value target reflects (1) lower earning estimates for the bank over our forecast period, and (2) amended valuation parameters in order to reflect higher risks for the industry. Year Net profit (SAR '000) BV (SAR '000) EPS (SAR) BVPS (SAR) Dec-11E 5,463,595 28,710,453 6.07 31.90 20.3 6.6 1.3 Dec-10E 4,918,195 25,159,814 5.46 27.96 20.9 7.3 1.4 Dec-09E 4,383,307 21,963,588 4.87 24.40 21.3 8.2 1.6 Dec-08 4,453,839 19,113,896 4.95 21.24 24.5 8.1 1.9 RoAE (%) P/E (x) P/BV (x) 52-week range (SAR) 38.2-102.5 Number of shares ('000) 900,000 Free Float (%)* 43 Market cap (SAR '000) 36,000,000 Market cap (USD '000) 9,615,600 Dividend Yield 2008 (%) 4.1 * in Q4 08, Kingdom Holding sold its 5% stake in Samba to Saudi Pension Fund bringing Saudi government agencies' stake in the bank to 49.5%
Investment thesis Samba's 2008 full year profit fell to SAR 4.5bn implying a 7.8% YoY decline (compared to an average decline of 14.2% for local banks). 2008 operating revenues slightly lingered by 2.6% YoY to SAR 7.0bn on the back of tightening spreads, mark-to-market losses on investments, and weak capital market activities. However, and despite times of tightening liquidity, Samba distinguished itself as one of the most liquid local franchises and undoubtedly the most efficient given its highest loan and deposit volumes per branch. Although Samba is the leading franchise among listed banks in terms of balance sheet size asserted by high capital adequacy and liquidity, we can not overlook the bank's low LDR (which could be shielding the bank's organic growth), its relatively low asset quality, and high dependence on market related revenues. These elements called for cautiousness in defining our key drivers which resulted in an overall downward revision of our forecasts. Yet, given the current share price of SAR 40.0, we reiterate our BUY rating on Samba given a fair value target of SAR 48.6 offering a 21.5% upside potential. Lowering our earnings' estimates Given the recent developments in the Saudi banking industry and as highlighted in our Saudi banking sector overview section (Appendix), we have conservatively assumed an 8.3% sector deposits growth over 2008-2013, matched by a slower 6.6% loans growth over the same period. As a result, this would decrease the Loans to Deposits Ratio (LDR) from 87% in 2008 to 80% by 2013. Going forward, we believe Samba's balance sheet is still apt for growth yet at lower rate than 2008. The bank's strategy will continue to serve loan book expansion yet maintaining caution and enhancing book quality while reinforcing its deposit base. In addition to that, the bank will continue de-risking its investment portfolio by concentrating on local government treasuries to aid reduce mark-to-market losses and insure a sustainable alternative source of income. Samba's deposit base is set to grow at a 2008-2013 CAGR of 6.9% while loans are estimated to increase at an annual average of 7.4% over the same period, translating to an average loan-to-deposit ratio for the forecast period of 74.1%. On the income statement, operating income and net profit are expected to increase at a CAGR (2008-2013) of 8.3% and 7.9% respectively. Valuation approach Our fair value target of SAR 48.6 per share resulted from two different methods: DECF valuation (70% weight) which yielded a FVT of SAR 55.4 per share and peer valuation (30% weight) resulted in a FVT of SAR 32.8. We have lowered our fair value target on Samba shares to SAR 48.6 from SAR 85.3 previously as our revised forecasts are reflective of (i) lower earnings' estimates for the bank on the back of slower loans growth (ii) tightening in net interest spreads accentuated by higher funding costs, (iii) higher NPLs, and (iv) lower market related revenues. In addition, we have changed our valuation parameters to reflect higher industry risk (i) increased cost of equity from 8.7% to 11.2%, and (ii) decreased perpetual growth from 4.5% to 2.5%. As the below graph shows, our revised forecasts led to a cut of SAR 12.4 per share of our previous DECF fair value target while the change in our valuation parameters implied a decrease of SAR 21.3 per share. March 22nd, 2009 14
New vs. Old DECF Fair Value Target 89.1 12.4 21.3 55.4 Previous DECF FVT Revised forecasts Revised valuation parameters New DECF FVT Our second valuation method is based on a regression of P/B multiple of a peer group of 19 GCC conventional banks against their 2009e RoAE. Based on the derived regression equation, Samba s relative valuation resulted in a value per share of SAR 32.8. March 22nd, 2009 15
Analysis and revised forecasts Slower deposit growth yet from a high base After reporting strong 22.1% deposits growth in 2007, Samba's FY 2008 total customer deposits reached SAR 134bn, growing 15.9% over FY 2007 - translating to a CAGR (2005-2008) of 16.3%, lower than the sector's 22.0% CAGR over the same period. Despite Samba's slower deposit growth, the bank still holds the largest customer deposit base among listed Saudi banks with a market share of 14.5%. 2008 deposits' level came 5% short of our previous forecast of SAR 141bn - we attribute the variation to Samba's already comfortable liquidity position which does not require it to rush for more deposits. However, against all odds and contrary to the sector s trend, Samba's annual deposits growth was credited to strong activity in Q4 08 which witnessed a 7.4% increase in deposits, higher than the preceding three quarters whose average growth was 2.6%. As of 2008-end, there was a shift in the bank's deposit base structure where 61% of total deposits were time deposits (up from 55% in 2007) mirroring the change in depositors' behaviour at times of increasing interest rates. However such a shift continued to be in short term deposits hence, did not improve the deposit maturity gap (calculated on contractual maturities) that Samba, similar to most Saudi banks, suffers from. Of 2008 total deposits, 87.4% were with 3 months and no fixed maturity (87.4% for 2007) continuing to raise concerns over bank's maturity risk. However, Samba's management believes that given the historical behavioural pattern of these deposits, a significant portion of those will stay with the bank for a longer term thereby reducing maturity risk. Looking ahead, we believe Samba will still grow its funding base through expanding from traditional middle-top tier customers (retail and corporate) to the more profitable massmarket. However Samba will underperform the sector in terms of growth given its already adequate base and comfortable liquidity position. In addition, the bank clarified that it had no intention to significantly expand its branch distribution network in the Kingdom as currently reliance on alternative channels is optimal. Given our forecast for the sector of a CAGR (2008-2013) of 8.3%, we forecast Samba's customer deposit CAGR for the same period at 6.9%. Though we agree that such growth estimates could be more pronounced, we stick to portraying a conservative scenario until further clarity arises for the kingdom's banking sector outlook. Customer Deposits (SAR mn) 2009e 2010e 2011e 2012e 2013e Old 159,991 178,341 193,678 201,986 208,652 New 146,486 157,951 168,546 178,236 187,018 New vs. Old -8.4% -11.4% -13.0% -11.8% -10.4% Source: SHUAA Capital estimates Although Samba did not see pressure on its funding costs in 2008 (due to declining benchmark rates), the bank is expected to witness higher cost of funding in the coming period as liquidity continues to be tight and banks are forced to increase deposits rates to preserve existing base and attract new depositors. Other funding sources Samba s due to banks grew massively to reach SAR 33.7bn by Q3 08, and sequentially dropped to SAR 12.1bn in one quarter by Q4 08. Apart from the seasonality effect of such borrowings (mainly USD dominated) usually taken against securities, we attribute this decline mainly to the tightening in the availability of USD dominated funds in the kingdom. March 22nd, 2009 16
During 2008, Samba, with ample liquidity on hand, did not tap into the debt market. Going forward, as the debt capital markets continue to be shut down, we do not foresee any debt issuances for Samba in our forecasts. Should market conditions change and Samba does actually tap into the debt market, this would add to the bank s upside potential. Samba keen on lending and treasury Parallel to the growth in commerce and retail sectors, Samba 2008 net loans and advances reached SAR 98.2bn, up 21.8% YoY, yet underperformed the sector's loans growth of 27.1%. Samba's loan book fell 12.5% short of our previous estimate of SAR 112bn on the back of excessive management cautiousness towards lending which led to slower funding growth and lower LDR target. Hence, Samba's market share of total local banks' loans slid to 12.8% over 2008, down from 13.5% in 2007. The expected slowdown in consumer spending and project finance in Saudi Arabia along with the bank s already conservative risk management policy warranted a downward revision to Samba's loan book growth in our projection period. In short, we expect the loan portfolio to expand at a 2009-2013 CAGR of 7.4% driven by an increasing, yet conservative, loan-to-deposit ratio (LDR) target. Nevertheless, this comes higher than the overall sector s CAGR (2009-2013) which is estimated at 6.6%. We also believe there could be an inherent upside potential to our assumptions over the medium to long term as the bank expands its reach to Pakistan and Dubai with the possibility of venturing into Qatar and Egypt at a later stage. Loans (SAR mn) 2009e 2010e 2011e 2012e 2013e Old 130,224 147,120 160,670 168,469 174,996 New 107,655 116,672 125,132 133,000 140,264 New vs. Old -17.3% -20.7% -22.1% -21.1% -19.8% Source: SHUAA Capital estimates Relative to its peers, Samba enjoys one of the best liquidity positions with a LDR of 72.1% at 2008-end (68.4% at 2007-end) giving the bank ample room to grow. In fact, the high lending potential reflected through Samba s low LDR puts the bank in a unique position to take advantage of the current market conditions as most competitors face stretched LDRs with limited capacity to lend. Another reason for Samba's low LDR is the partial allocation of its fund to treasury investments and away from its core lending activities. Going forward, we think the bank will partly regroup its focus back to the lending activity while slightly decelerating its treasury activity. This would lead to a lower LDR (including term loans) of 75.0% by 2013 representing an average of 74.1% over 2009-2013 vs. 81.3% in our previous assumption. Loans to deposits ratio 2009e 2010e 2011e 2012e 2013e Old 79.8% 80.9% 81.5% 82.0% 82.5% New 72.6% 73.9% 74.2% 74.6% 75.0% New vs. Old (in bps) -724-703 -726-738 -750 Source: SHUAA Capital estimates Despite its low LDR and conservative lending policy, Samba's NPLs/ Gross Loans ratio stood at 1.8% at 2008 end - one of the highest among Saudi banks. This was primarily the result of inherited NPLs following the merger with United Saudi Bank. Though we credit Samba for successfully reducing its NPL/Gross loan ratio from 2.3% in FY 07 to this historical low of 1.8% in FY 08, we raise it to an average of 2.7% in our forecast period given the higher probability of defaults in the medium term due to expected regional economic slowdown. However, and despite the marginally higher anticipated risk, we believe Samba has built up a provisioning cushion which would enable it to report a lower YoY provision coverage ratio of 127% in 2009, before reinforcing it up to 160% by 2013 as its loan book volume increases. March 22nd, 2009 17
NPLs/Gross Loans 2009e 2010e 2011e 2012e 2013e Old 2.3% 2.3% 2.3% 2.3% 2.3% New 2.6% 2.7% 2.8% 2.8% 2.8% New vs. Old (in bps) 25 35 45 45 45 Provision Cover 2009e 2010e 2011e 2012e 2013e Old 113% 109% 111% 117% 124% New 127% 133% 138% 149% 160% Source: SHUAA Capital estimates 4,500 4,000 3,500 3,000 NPLs and NPLs/Gross Loans 3,204 2,837 3,576 3,813 4,034 3% 3% 2% 2,500 2,000 1,840 2% 1,500 1% 1,000 500 1% - 2008 2009e 2010e 2011e 2012e 2013e NPLs (SAR mn) NPLs/Gross Loans Source: SHUAA Capital estimates 0% As for the bank s investment strategy, Samba's management appears to be keen on maintaining a sound yet conservative policy. However, the plan seems to favour a slight shift towards the lending side of the business as opposed to investing. At 284% as of 2008-end (312% for 2007), Samba had the highest total investments/total equity ratio among local peers raising investors concerns over the bank s high exposure to securities of which part was in held at fair value through income statement (FVIS) portfolio. Later on, Samba shifted its focus to investing more in government bonds which represented, as of 2008-end, around 82% of total investments. In addition, the bank liquidated around half of its equity positions in H2 08. These moves were intended to hedge against deteriorating market conditions while minimizing capital market exposure and providing stable revenue streams. Going forward, we believe the bank will continue its investments in risk-free government bonds with total investments expected to grow at a CAGR of 7.5% throughout our forecast period. Market conditions to weigh on 2009 revenues Samba net special commission income reached SAR 5.1bn in FY 08, up from SAR 4.9bn in FY 07, translating to a net interest spread of 3.6%. These results came 3.8% below our estimate of SAR 5.3bn on the back of lower than expected volume growth. Going forward, overall spreads are expected to be slightly under pressure due to increasing liquidity premiums. This however, will somewhat be offset by the bank s loan re-pricing. In short, we expect spreads to average 3.3% over 2009-2013 with net interest margin hovering around 3.4% over our forecast period. Samba's operating line was supported by the fee and commission revenues which remained flat YoY at SAR 1.6bn but slightly below our initial expectation of SAR 1.7bn. The lower than expected figure was due to a slowdown in general market activity which was witnessed in the last quarter of 2008. Share trading and fund management was directly impacted by the lower equity activity on Tadawul recording a decline of 27.9% to SAR 651mn. On the other hand, the relatively stronger trade finance activity (SAR 234mn in 2008, +26.3% YoY) and investment banking operations (SAR 259mnin 2008 ; +121.9% YoY) padded net fee and commission income. In 2009, we believe this line will suffer from continuing weak trading values and a slow investment banking activity, at least in the March 22nd, 2009 18
first half of the year. Nevertheless, net fee and commission income is expected to grow at a CAGR (2009-2013) of 14.4 % sustained by an expected strong focus on cross-selling (including broad client coverage and product reach) and contributing to an average of 21.7% to total operating income. On the investments side, Samba marked-to-market SAR 646mn worth of losses related to its FVIS portfolio on its 2008 income statement. However, the bank managed to offset the losses by reporting gains of SAR 501mn on its non-trading investments (government bonds portfolio), as yields drop in the last quarter of 2008. Going forward, we expect interbank rates to stabilize and foresee no significant gains on the bank s non-trading investments. At the same time, we believe that the 2008 liquidation of the FVIS portfolio would limit the extent of any potential mark-to-market loss. Overall, the total non-interest income is set to grow at a CAGR (2008-2013) of 9.5%. Operating expenses On an annual basis, non-interest expenses increased by a relatively low rate of 7.6% to reach SAR 2.6bn as the bank decided not to add branches in 2008 while capitalizing on the efficiency of alternative distribution channels. However, the marginal decrease in operating income pushed the bank s cost to income ratio to 30.1% in 2008 from 27.3% in 2007. Going forward, we believe the bank s decision to control costs, through limiting branch expansion, will help stabilize its cost-to-income ratio around the 2008 levels of 30%. Returns and CAR In 2008, Samba's net profit reached SAR 4.5bn registering a drop of 7.8% YoY. While underperforming listed banks average of -0.9%, the fall came in softer than that of the local banks (including NCB) which marked a decline of 14.2% YoY. Based on our revised forecasts, we believe Samba will report a slight 1.6% decline in earnings in 2009 (and RoAE to reach 21.3% ) due to higher provisions while growing thereafter at a CAGR (2009-2013) of 10.5% on the back of loan book expansion, with ROAE declining to 19.4% by 2013. In turn, we expect the bank to maintain a healthy Tier 1 capital ratio of no less than 14% leaving much room for organic as well as inorganic growth, inline with the bank's medium term vision to establish presence in selective MENA markets. 7,000 6,000 5,000 Returns 4,454 4,383 4,918 5,464 5,987 6,526 30% 25% 20% 4,000 3,000 15% 2,000 10% 1,000 5% 0 2008 2009e 2010e 2011e 2012e 2013e Net Profit (SAR mn) ROAE Source: SHUAA Capital estimates 0% March 22nd, 2009 19
Valuation Our fair value target of SAR 48.6 per share is from the resultant of two different methods: DECF valuation (70% weight) which yielded a FVT of SAR 55.4 per share and peer valuation (30% weight) resulted in a FVT of SAR 32.8. Value per share (SR) Weighting DECF 55.4 70% Relative valuation 32.8 30% Fair value 48.6 Our DECF for Samba results in a fair value of SAR 55.4 per share. It is based on a five year cash flow forecast period and a fading period of 25 years during which the RoAE approaches cost of equity at 11.6%. Free cash flows are calculated by deducting the retentions required from projected net income to maintain a tier 1 capital ratio of at least 12.5% (as per management guidelines). In addition and in order to reflect overcapitalization and over provisioning of the bank, we have also incorporated PV of excess capital and PV of excess provisioning in the terminal value. Also, we have changed our valuation parameters to reflect heightening risk profile of the industry, translating to into an increase in the cost of equity to 11.2% up from 8.7% in our previous assessment. In addition, perpetual growth was lowered to 2.5% from a high 4.5% previously. OLD NEW Risk free rate 4.7% 6.0% Market risk premium 5.0% 5.0% Beta 0.80 1.04 Cost of equity 8.7% 11.2% As a result, revision of our earnings estimates led to a SAR 12.4 per share cut of our previous DECF fair value target, while change of our valuation parameters translated into a SAR 21.3 downgrade. Our second valuation method is based on a regression of the P/B multiple of a peer group of 19 GCC banks against 2009e RoAE. Based on the derived regression equation, relative valuation of Samba resulted in a value per share of SAR 32.8. March 22nd, 2009 20
Financials Samba Financial Group Balance Sheet - SAR '000 Year to December 2008E 2009E 2010E 2011E 2012E 2013E Cash & Balances with SAMA 13,799,946 15,133,979 15,955,791 17,135,895 18,340,417 19,141,261 Due from Banks 877,977 1,907,566 2,195,581 2,371,488 2,588,948 2,801,633 Investments, net 54,212,716 56,411,689 61,935,014 67,321,545 72,559,586 77,641,298 Loans & advances (net of provision) 98,147,182 107,655,068 116,671,785 125,131,940 132,999,758 140,263,834 Investments in an associate 6,130 6,130 6,130 6,130 6,130 6,130 Property and equipment, net 870,086 887,488 905,237 923,342 941,809 960,645 Other assets 10,977,153 11,327,266 11,688,545 12,061,347 12,446,040 12,843,002 Total assets 178,891,190 193,329,185 209,358,084 224,951,687 239,882,687 253,657,803 Customer deposits 134,228,465 146,485,844 157,950,648 168,545,877 178,235,906 187,018,445 Due to banks 12,089,957 13,193,979 14,678,451 15,341,642 16,223,662 17,023,080 Debt securities issued 1,873,041 1,873,041 - - - - Other liabilities 10,637,862 8,799,431 10,453,420 11,135,165 11,775,347 12,355,575 Total liabilities 158,829,325 170,352,296 183,082,520 195,022,684 206,234,916 216,397,101 Minority Interest 216,080 224,306 230,476 235,103 238,573 241,176 Total shareholders' equity 19,113,896 21,963,588 25,159,814 28,710,453 32,062,044 35,388,050 Proposed dividends 731,889 788,995 885,275 983,447 1,347,155 1,631,477 Total liabilities and equity 178,891,190 193,329,185 209,358,084 224,951,687 239,882,687 253,657,803 Samba Financial Group Income Statement - SAR '000 Year to December 2008E 2009E 2010E 2011E 2012E 2013E Special commission income 8,425,855 9,773,252 10,760,470 11,654,417 12,493,754 13,290,455 Special commission expense -3,364,612-4,564,852-4,954,575-5,269,497-5,591,505-5,889,356 Net special commission income 5,061,243 5,208,400 5,805,895 6,384,919 6,902,249 7,401,099 Net fee and commission income 1,623,867 1,447,113 1,669,919 1,897,580 2,166,431 2,478,686 Net gains from FX transactions 408,980 417,160 425,503 434,013 442,693 451,547 Trading income 22,898 24,043 25,245 26,507 27,833 29,224 Income on investments held at FVIS -645,984 - - - - - Gains on non trading investments 500,974 44,375 48,581 53,939 58,545 63,052 Other operating income 39,923 30,700 34,222 37,635 40,685 43,625 Total non-interest income 1,950,658 1,963,391 2,203,471 2,449,675 2,736,187 3,066,134 Total income from operations 7,011,901 7,171,791 8,009,366 8,834,594 9,638,436 10,467,233 Staff and general expenses -1,366,115-1,434,358-1,641,920-1,855,265-2,072,264-2,302,791 Rent and premises related expenses -198,727-205,087-209,188-213,372-217,639-221,992 Provisions for credit losses -267,082-538,275-641,695-688,226-731,499-771,451 Provision for impairment of investments -190,908-55,312-29,587-32,314-34,970-37,550 Depreciation -136,941-141,323-144,150-147,033-149,973-152,973 Other G&A expenses -409,257-422,354-430,801-439,417-448,205-457,169 Total non-interest expenses -2,569,030-2,796,709-3,097,340-3,375,626-3,654,551-3,943,927 Profit before tax 4,442,871 4,375,081 4,912,025 5,458,968 5,983,885 6,523,306 Minority Interest -10,968-8,226-6,170-4,627-3,470-2,603 Net profit 4,453,839 4,383,307 4,918,195 5,463,595 5,987,355 6,525,909 March 22nd, 2009 21
Samba Financial Group - Key ratios - %, unless otherwise stated Year to December 2008 2009E 2010E 2011E 2012E 2013E Growth Equity 11.2 14.9 14.6 14.1 11.7 10.4 Assets 15.9 8.1 8.3 7.4 6.6 5.7 Loans 21.8 9.7 8.4 7.3 6.3 5.5 Deposits 15.9 9.1 7.8 6.7 5.7 4.9 Net special commission income 2.4 2.9 11.5 10.0 8.1 7.2 Operating income -2.6 2.3 11.7 10.3 9.1 8.6 Net profit -7.8-1.6 12.2 11.1 9.6 9.0 Capital Adequacy Tier 1 capital 13.6 12.8 13.5 13.5 13.1 13.2 Equity / assets 10.7 11.4 12.0 12.8 13.4 14.0 Asset Quality NPL / Gross Loans 1.8 2.5 2.6 2.7 2.7 2.7 LLP / NPL 167.0 127.3 132.7 138.2 148.8 159.8 Margins and Profitability Interest Spread 3.6 3.3 3.4 3.4 3.4 3.4 Net interest Margin 3.6 3.3 3.4 3.5 3.5 3.5 Net Profit Margin 42.9 37.3 37.9 38.7 39.3 39.9 RoAE 24.5 21.3 20.9 20.3 19.7 19.4 RoAA 2.7 2.4 2.4 2.5 2.6 2.6 Liquidity Loans / Interest Earning Assets 65.5 66.0 65.7 65.4 65.0 64.7 Loans / (Deposits+Term loans) 72.1 72.6 73.9 74.2 74.6 75.0 Efficiency Cost/income 30 31 30 30 30 30 March 22nd, 2009 22