(DISB.du) Equity Research Initial Coverage October 1st, 2007 Current Price: aed 9.62 Country: United Arab Emirates Fair value Target: AED 10.58 Sector: Commercial Banking Recommendation: BUY Exchange: Dubai Financial Market Sector Coverage Team Mohamed El Nabarawy, CFA +9714 3199 756 melnabarawy@shuaacapital.com George Beshara +9714 3199 837 gbeshara@shuaacapital.com Dubai Islamic Bank (DIB), established in 1975, is one of the first Islamic banks to be established in the world. The bank has grown substantially over the years and now ranks 5th among UAE banks in terms of assets and shareholders equity. Its profitability has witnessed phenomenal growth over the past few years, from AED160 million in 2001 to AED1.56 billion in 2006, growing 10 times within a short span of five years. DIB operates through five main business groups: retail banking, corporate banking, real estate, investment banking, and proprietary trading investments. Retail banking, real estate related activities and investment banking, primarily in debt capital markets, are the major contributors to revenues, counting for around 83% of revenues in 2006, and are likely to continue to be the drivers of growth going forward. We initiate coverage on Dubai Islamic Bank with a Buy recommendation based on a target value of AED 10.58 per share, implying an upside of 10.0% to the current market price of AED 9.62 per share. Year Net profit (AED 000) BV (AED 000) EPS (AED 000) BVPS (AED 000) Dec-09E 2,940,790 13,021,687 0.98 4.35 24.5% 9.8 2.2 Dec-08E 2,477,230 10,963,134 0.83 3.66 24.6% 11.6 2.6 Dec-07E 2,425,198 9,204,300 0.81 3.07 29.3% 11.9 3.1 Dec-06 1,560,093 7,361,150 0.52 2.46 29.8% 18.5 3.9 RoAE (%) P/E (x) P/BV (x) 52-week range (AED) 6.10-11.07 Number of shares (000 ) 2,996,000 Free Float (%) 66 Market cap (AED 000) 28,821,520 Market cap (USD 000) 7,848,784 Div. Yld. 2006 (%) 2.1 Source: Reuters, SHUAA Capital 20.00 15.00 10.00 5.00 - DIB stock performance vs. SC UAE Index 3/1/2005 5/1/2005 7/1/2005 9/1/2005 11/1/2005 1/1/2006 3/1/2006 5/1/2006 7/1/2006 9/1/2006 11/1/2006 1/1/2007 3/1/2007 5/1/2007 7/1/2007 SC UAE Index Rebased DIB (AED)
Contents Investment Highlights...3 Overview of Dubai Islamic Bank...4 Business model... 4 Core strategy... 5 Credit Rating... 6 Islamic Banking in the region...7 History... 7 Islamic banking in the GCC... 8 Islamic banking in the UAE... 8 Analysis & Forecasts...10 Sources of Funds... 10 Asset allocation... 11 Net interest income and interest spreads... 12 Fees and commissions... 13 Real estate... 14 Proprietary investments portfolio... 15 Other associates... 15 Efficiency... 16 Capital adequacy... 16 Return... 16 Valuation...17 Discounted equity cash flow (DECF) valuation... 17 Relative valuation... 17 Financials...19 October 1st, 2007 2
Investment Highlights Dubai Islamic Bank (DIB), established in 1975, is one of the first Islamic banks to be established in the world. The bank has grown substantially over the years and now ranks 5th among UAE banks in terms of assets and shareholders equity. Retail banking, which accounted for 38% of operating income in 2006, is expected to continue being a major contributor to revenues on the back of an aggressive branch expansion underway. The bank is planning on opening11 branches by the end of 2007, thus bringing its overall network to 52 branches. Real estate is major area of strength for DIB contributing 28% of operating income in 2006. The bank is a leader in real estate financing in the UAE and has been successful in establishing a number of subsidiaries and associates that operate in real estate related business. This includes Tamweel, a leading provider of mortgage finance in the UAE, and Deyaar Development, a large Dubai-based real estate development company. The bank has managed to position itself as one of the leading financial institutions in managing debt issuances in the region. The bank is one of the top five sukuk managers in the world. Debt capital market activities accounted for 17% of operating income in 2006. We expect deposits for DIB to grow at a CAGR of 17% in 2006-2011 on the back of: 1) a bullish outlook on the growth in the UAE economy 2) increased demand for Islamic banking products and 3) DIB s aggressive branch network expansion. We are bullish on the bank s ability to increase its loans on the back of a positive outlook on the UAE economy and a healthy liquidity position at the bank. Loans to deposits ratio amounted to 74% in 2006 and we expect it to hover around 85% going forward. This implies that loans will grow at a CAGR of 17% throughout the projection period. We expect DIB to increase its net income to AED 2.43 bn in 2007, 55% higher than 2006 full year figures. The growth is expected to be driven by a strong growth in the balance sheet as well as AED 617 mn in gains on revaluation from the transfer of DIB s stake in Deyaar Development. We are forecasting a 2% growth in net income in 2008 and a CAGR of 22% throughout 2006-2011. We initiate coverage on Dubai Islamic Bank with a Buy recommendation based on a target value of AED 10.58 per share, implying an upside of 10.0% to the current market price of AED 9.62 per share. 200,000 AGM approves bonus share dividends and cash dividends of 20% DIB recorded net profit of AED1.5 billion in 1H FY07 180,000 DIB closes US$ 1billion 160,000 Ijara facility lead managed by DIB DIB grated A long-term credit rating from S&P 140,000 120,000 100,000 80,000 60,000 40,000 20,000-31/12/05 31/03/06 30/06/06 30/09/06 31/12/06 31/03/07 30/06/07 Average Daily Traded Value (AED'000) Monthly Adjusted Closing Price (AED) 450 400 350 300 250 200 150 100 50 - October 1st, 2007
Overview of Dubai Islamic Bank DIB was established in 1975 Incorporated in 1975, Dubai Islamic Bank (DIB) is among the first Islamic banks to be established in the world. The Dubai-based bank offers a full range of banking services that comply with the Islamic Sharia principles. DIB has grown substantially over the years and now ranks 5th among UAE banks in terms of assets and shareholders equity. Its profitability has witnessed phenomenal growth over the past few years, rising 10 times within a short span of five years - from AED160 million in 2001 to AED1.56 billion in 2006. Its branch network has grown from 19 branches in 2003 to more than 41 in the UAE with plans to launch additional 11 branches by the end of 2007, thus bringing its overall network to 52 branches. and is 30% owned by the Dubai government The Government of Dubai s ownership in the bank is a relatively recent development, instigated in 1998, at a time when the bank faced major financial difficulties. It is believed that fraud was behind the crisis which resulted in a run of deposits in April of the same year. Government intervention took place in the form of injecting capital into the bank, giving the government a 30% stake in the bank, which was initially founded by a group of private businessmen. The bank has since completely restructured its operations and management. The current holding includes 30% by government of Dubai and 4% by UAE Federal Pension Fund. DIB shareholders structure Dubai Government 30% Free float and other 66% Federal Government pesnsion fund 4% Source: DIB Business model DIB operates through five main business groups: retail banking, corporate banking, real estate, investment banking, and proprietary trading investments. Retail loans represented 17% of the total loan portfolio for DIB in 2006 as opposed to 25% for the average UAE banking sector. Though retail banking does not constitute a major portion of the bank s loan book, it contributed 38% of revenues in 2006, indicating that it is a high yield component. The retail banking business has been strengthened by the bank s aggressive branch expansion program through which 12 branches were added in 2006 and a further 14 branches are due to be added in 2007. The bank has recently launched several new retail products including personal finance, Islamic credit cards and a mortgage product. Corporate banking includes small and medium enterprises, large corporations, as well as government and government related entities. It does not include real estate companies as those are considered part of the bank s real estate division. Corporate banking represented 34% of the bank s loan portfolio and contributed 11% of total revenues in 2006. October 1st, 2007
Investment Banking 17% DIB s investment banking business, which represented 17% of total revenues in 2006, is executed primarily through the two majority owned subsidiaries, Millennium Capital and Millennium Finance. DIB is one of the leading banks in the world in managing Islamic debt (sukuk) issuances, ranked 3rd in the global Islamic bond league table in 2006. DIB is among UAE s leading providers of real estate finance. The bank plays a major role in supporting infrastructure and real estate developments, ranging from construction of road networks and bridges to commercial property, residential estates, and high-rise buildings. In addition to real estate financing, the bank s exposure to real estate is also in the form of a stake in Deyaar Development, and an AED1.0 bn portfolio of investment properties. Real estate contributed 28% of total revenues in 2006, of which 15% was contributed by Deyaar, 9% from real estate financing, and 4% from income on the investment in a properties portfolio. Trading investments and portfolio: Trading investments and portfolio include DIB s investments in both the equity and the fixed income markets and represents around 6% of operating income in 2006. DIB revenue breakdown 2006 Treasury 6% Retail Banking 38% Direct Equity 15% Real Estate/Contract Corporate Banking Financing 11% 13% Source: DIB, SHUAA Capital Core strategy Retail banking, real estate activities and investment banking, are the major contributors to revenues, counting for around 83% of revenues in 2006 Dubai Islamic Bank stands out among other conventional and Islamic banks in the UAE by being one of the first Islamic banks to be established. It has since built a strong franchise which was utilized to take advantage of a growing demand for Islamic banking products in the UAE and the broader region. Retail banking, real estate related activities and investment banking, primarily in debt capital markets, are the major contributors to revenues, counting for around 83% of revenues in 2006. Its strategy at this time focuses on these areas of proven strength and strong expected growth going forward. The core components of this strategy include: Retail banking, which accounted for 38% of total revenues in 2006, is expected to continue being a major contributor to revenues on the back of an aggressive branch expansion underway in the UAE. The bank will likely continue to place particular emphasis on retail product development, with an eye to compete both with conventional banks, as well as Islamic banks in the UAE. The bank s ability to grow its balance sheet and its loan book substantially at this stage further supports the push towards further growth in its retail portfolio. Real estate related activities are another area of strength for DIB. The bank is a leader in real estate and construction financing in the UAE. Moreover, it has been successful in October 1st, 2007
The bank is a leader in real estate and construction financing in the UAE The bank ranked 3rd in the global Islamic bond league table in 2006 The bank s strategy is to further strengthen its position within the UAE market and gain market share by rolling out new branches and introducing new products establishing a number of subsidiaries and associates that operate in real estate related businesses. These include Tamweel, a leading provider of housing finance in the UAE, and Deyaar Development, a Dubai-based real estate development company. Both companies were founded by DIB in 2004 and 2001 respectively, and both are currently listed on the Dubai Financial Market. This strategy has resulted in the bank, more than any other in the UAE, being an active participant across the full value chain of a booming real estate industry in the country. While this exposure undoubtedly carries some risk, the quality and relative liquidity of the exposure substantially mitigates the risk in case of a downturn. Debt capital markets (DCM) is an area of clear success for DIB, as the bank has managed to become one of the leading financial institutions in managing Islamic debt (sukuk) issues worldwide in 2006. The bank ranked 3rd in the global Islamic bond league table in 2006. At the heart of this enviable position claimed by the bank is the unprecedented growth in issuance of Sharia compliant bonds (Sukuk) in the region; a development that has proven to be a boon for the bond industry as a whole in the Middle East. Success in building a strong franchise in debt capital markets, at a time when the market is witnessing a boom, has and will likely continue to boost returns generated by the bank, and represent a core fee income component for the bank going forward. This business line has helped make DIB the bank with the most diversified revenue stream in the country, as well as the bank with the least dependence on spread income. Despite an active year of cross boarder consolidation within the regional banking industry, DIB has been almost exclusively focused on its local market. The bank s strategy is to further strengthen its position within the UAE market and gain market share by rolling out new branches and introducing new products. The new management, which came on board in 2003, implemented a strategy whereby the bank does not sell its products solely based on being Islamic compliant but rather introduces products and services that are competitive with those offered by conventional banks, while also leveraging the bank s franchise and core competencies. We believe that the core strategy adopted by DIB s management is not only suitable, but indeed optimal at this stage. We believe that the bank will continue to cement its core franchise in the UAE, and benefiting from the highest growth components available to the industry will grow market share in the country s banking industry as a whole. This will be achieved without undue distraction from a large scale regional expansion strategy that may prove both expensive and time consuming. We believe that components of DIB s activities, including its real estate and DCM franchise, will prove more scalable and more suitable for a regional strategy over the medium term, while the primary spread business will continue to focus on opportunities for growth within the UAE. Credit Rating DIB has been given amongst the highest bank ratings in the Middle East, confirming the bank s solid financial position and strong franchise and brand name. The bank has been assigned A/stable/A-1 from Standard and Poor s and P-1 and A1 from Moody s. October 1st, 2007
Islamic Banking in the region History The first Islamic bank was established in Egypt in 1963 The size of the Islamic banking assets has grown from USD 10 bn in the early 1980s to USD 250 bn by 2007 Islamic banking is restricted to Islamically acceptable dealings, which exclude those involving usury, alcohol, pork, gambling, etc Although it is generally accepted that the first commercial Islamic bank to be established globally was Dubai Islamic Bank, the first bank in the world to operate under Islamic sharia principals was in-fact established in Egypt in 1963 and was called the Mit Ghamr Local Savings bank. The relative success of the bank proved that a bank operating according to Islamic principles could indeed flourish. Following this initial success, a number of Islamic banks were founded in the mid 1970s onwards, including Dubai Islamic Bank (1975), Faisal Islamic Bank in Egypt (1976) and Kuwait Finance House (1979). In order to coordinate Sharia rulings between Islamic banks in different countries, an International Association of Islamic banks was established in 1977, with its headquarters in Saudi Arabia. The Islamic banking industry has been experiencing phenomenal growth over the past three decades. From a highly specialized niche market, Islamic banking has grown into a multi-billion dollar global industry working alongside its conventional counterpart. The size of the Islamic banking assets has grown from USD 10 bn in the early 1980s to USD 250 bn by 2007, representing around 1% of global banking assets. The number of Islamic banks reached 267 in 2005, of which 91 banks were added between the years 2000 and 2005 alone. Today, Islamic finance exists in over 75 countries, offering a broad and sophisticated range of financial products and services. High population growth in Muslim nations, a rise in crude oil prices, the propensity of Middle Eastern investors to redirect their investments into the region post September 11th, as well as the acceptance of Islamic banking as a mainstream component of global finance, have been the primary drivers of growth in Islamic finance over the past decade. What is Islamic banking? Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, or Islamic law. It is restricted to Islamically acceptable dealings, which exclude those involving usury, alcohol, pork, gambling, etc. Islamic banks are required to establish Shariah advisory committees to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of usury (conventional interest). Amongst the common Islamic concepts used in Islamic banking are profit sharing (Mudharabah), (Musharakah), cost plus (Murabahah), and leasing (Ijarah). Mudaraba Mudaraba transaction is an investment partnership whereby the contract is between a bank (or an investor) and an entrepreneur or investment manager. In the case of a profit, both parties receive their agreed-upon share of the profit. In the case of a loss, the bank bears any loss of capital while the entrepreneur loses his time and effort. Murabaha An agreement whereby the bank sells to a customer a commodity or an asset, which the bank has purchased and acquired based on a promise received from the customer to buy the item purchased according to specific terms and conditions. The selling price comprises the cost of the commodity and an agreed profit margin. The conventional banking equivalent is cost plus financing. Musharaka An agreement between the bank and a customer to contribute to a certain investment enterprise, whether existing or new, or the ownership of a certain property either permanently or according to a diminishing arrangement, ending up with the acquisition by the customer of the full ownership. The profit is shared as per the agreement set between both parties while the loss is shared in proportion to their shares of capital in the enterprise. The conventional banking equivalent is joint venture or partnership financing. October 1st, 2007 7
Ijarah An agreement whereby the bank purchases or constructs an asset for lease according to the customer s request, based on his promise to lease the asset for a specific period and against certain rent installments. Ijarah could end by transferring the ownership of the asset to the lessee. The conventional banking equivalent is leasing. Islamic banking in the GCC Islamic banking has historically been dominated by locally established banks in the GCC, as the sector remained a locally contained phenomenon for much of its history. More recently, a growing number of foreign banks are also joining the fray. Some of these, such as Barclays Capital, Deutsche Bank, Citigroup, BNP Paribas and HSBC are establishing special Islamic windows, or branches, of their operations in the Middle East, which run according to sharia-compliant principles. There are currently 15 publicly listed Islamic banks in the GCC, accounting for 23% of the total listed banks assets as at the end of 2006 There are currently 15 publicly listed Islamic banks in the GCC, accounting for 23% of the total listed banks assets as at the end of 2006. Oman is the only exception with no Islamic banks within its borders, as banking regulations in the country do not allow for it. Publicly listed Islamic banks in the GCC Assets (USD 000) Date of establishment Country Al Rajhi Bank 28,055,665 1987 KSA Kuwait Finance House 21,840,226 1977 Kuwait Al Baraka Banking Group 20,227,658 2002 Bahrain Dubai Islamic bank 17,750,396 1975 UAE Abu Dhabi Islamic Bank 9,997,364 1997 UAE Shamil Bank 4,491,406 1982 Bahrain Bank Al Jazira 4,190,100 1975 KSA Qatar Islamic Bank 4,020,030 1982 Qatar Bank Al Bilad 3,099,276 2004 KSA Emirates Islamic bank 2,885,331 1976 UAE Qatar International Islamic Bank 2,307,125 1990 Qatar Sharjah Isalmic bank 2,105,113 1975 UAE Boubyan Bank 1,791,104 2004 Kuwait Masraf Al Rayan 1,188,004 2006 Qatar Bahrain Islamic Bank 1,157,761 1979 Bahrain Total Islamic Banks Assets 125,106,558 Total Banks Assets 538,791,503 % of total 23.2% Source: SHUAA Capital Islamic banking in the UAE Out of the 46 banks currently present in the UAE, five are considered Islamic Of the 46 banks currently present in the UAE, five are considered Islamic. Dubai Islamic Bank and Abu Dhabi Islamic Bank are the only two banks in the UAE that were founded as Islamic Banks. The other three have taken the conversion route, having originally been conventional banks. Emirates Islamic Bank, the retail arm of Emirates Bank International, was originally founded under the name of Middle East Bank, while Sharjah Islamic Bank was established as National Bank of Sharjah. Dubai Bank, which was founded in 2002, changed its operations to become Islamic compliant in 2006. The number of Islamic banks in the UAE is expected to reach seven with the establishment of two new banks, Al Noor Islamic Bank and the Crescent Bank. Al Noor Islamic Bank was founded by Dubai Holding, an investment holding conglomerate, with a capital of AED 3.7 bn, while Crescent Bank was founded by the Abu Dhabi Investment Council, an investment arm of the Abu Dhabi government, with a capital of AED 4 bn. To take advantage of the growing demand for Islamic products and services, many conventional banks have introduced October 1st, 2007
strategies such as opening Islamic windows or starting fully dedicated Islamic finance companies. Several local banks such as Mashreq, RAK Bank, First Gulf Bank, Union National Bank and Commercial Bank International have either started or announced plans to open Islamic finance arms. Islamic banks have been growing at impressive rates and are gaining market share of total UAE banking assets The three listed Islamic banks have been outperforming conventional banks in terms of balance sheet growth. Their share of the total assets reached 17% in 2006 up from 14% in 2003. Total assets for the three listed banks (Dubai Islamic Bank, Abu Dhabi Islamic Bank and Sharjah Islamic Bank) grew at a CAGR of 46% vs. 37% for conventional banks over the same period. UAE Islamic Banks market share 120,000 100,000 80,000 60,000 40,000 20,000-2003 2004 2005 2006 Islamic banks assets (AED mn) Market share 17% 17% 16% 16% 15% 15% 14% 14% 13% 13% Source: Banks financials, SHUAA Capital October 1st, 2007
Analysis & Forecasts Sources of Funds Customer deposits is the core funding source DIB s funding mix is diversified in line with the other UAE banks as customer deposits represented 80% of total interest bearing funds, compared to 78% for the sector average. Customer deposits have been growing at impressive rates in the past two years. Consequently, the bank s market share in deposits increased from 8.1% in 2005 to 9.7% in H1 2007 placing DIB at No. 2 in terms of deposits in the banking industry in the UAE. 70,000 9.67% 10% 60,000 50,000 40,000 30,000 20,000 8.15% 8.25% 8.30% 8.37% 8.55% 9.29% 10% 9% 9% 8% 10,000 8% 0 7% FY05 Q1 FY06 1H FY06 DIB deposits Market Share 9M FY06 FY06 Q1 FY07 1H FY07 Source: SHUAA Capital We expect deposits for DIB to grow at a CAGR of 17% in 2006-2011 on the back of. a bullish outlook on the growth in the UAE economy. increased demand for Islamic banking. and an aggressive branch expansion underway Strong interest on Islamic products to fuel deposits growth rate Going forward, we expect deposits for DIB to grow at a CAGR of 17% in 2006-2011 on the back of: 1) a bullish outlook on the growth in the UAE economy 2) increased demand for Islamic banking and 3) DIB s aggressive branch expansion. The UAE economy grew by 8.9% in 2006 and is expected to grow by 8.5% in 2007. Deposits to GDP stand at around 90%. Assuming this ratio remains unchanged throughout the projection period implies that total deposits in the UAE are expected to grow at a CAGR of 11%. Demand for Islamic banking in the UAE has been growing as is evident by the rising market share of deposits by Islamic banks from 8% in 2003 to 12% in 2006. The rising market share of Islamic banks also resulted from some conventional banks converting their operations to become Islamic compliant. These include Emirates Islamic Bank, Sharjah Islamic Bank and Dubai Bank. In 2006, DIB added 10 branches and is planning to add 14 branches in 2007 to bring its total number of branches to 52 by the end of 2007. Accordingly, we foresee DIB to register total deposits figure of AED66 billion in 2007 up from AED59 billion in H1 2007. Throughout our five years forecast horizon, we expect DIB total deposits to outperform the sector, translating to total deposits CAGR of 17% as opposed to 11% for the sector. In Q1 2007, DIB has launched its first Sukuk to diversify its overall funding base DIB introduced Sukuk as alternative source of fund In Q1 2007, DIB has launched its first Sukuk to diversify its overall funding base. The Sukuk issuance, which was rated A/stable/A-1 by S&P, amounted to AED2.7 billion and was priced at Libor + 34 bps. We believe that this change in the funding base will raise the bank s funding cost as the Sukuk are more expensive relative to customer deposits. Additionally, we see room for further Sukuk issuances as the bank has been lagging behind other UAE banks in terms of Sukuk issuance. The table below depicts a comparison between the Sukuk sizes relative to assets size among peers. October 1st, 2007 10
Sukuk to Assets H12007 Bank (AED000) Sukuk Assets Sukuk/assets NBAD 7,304,150 123,998,245 6% ADCB 24,002,108 96,098,250 25% UNB 5,692,545 45,268,984 13% FGB 2,754,750 57,236,230 5% DIB 2,754,750 75,535,450 4% NBDD 9,763,926 80,925,871 12% Total 52,272,229 479,063,030 11% Source: Banks financials Cost of funds are expected to drop in 2008 on the back of the recent interest rate cuts by the UAE Central Bank Cost of funds to drop in 2008 on the back of lower interest rates Funding cost amounted to 3.36% in 2006, up from 2.45% in 2005. The higher funding cost resulted from higher interest rates on the UAE dirham which are pegged to USD interest rates. We expect cost of funds to remain almost unchanged in 2007 and drop by 50 bps in 2008 in line with the latest interest rate cuts by the UAE Central Bank and the US Federal Reserve. The US Federal reserve has recently cut the US Federal Funds Target Rate by 50 bps, while the UAE Central Bank has cut rates on CDs by 25 bps only. The market in the US is pricing another 25 bps cut (at least, if not 50 bps). Asset allocation Loans are the main income contributor Loans, or financing and investing assets, represent the bulk of earnings assets. Financing assets are diversified among Murabahat, Istisna a and Ijara. Murabahat is an agreement whereby the bank sells to a customer an asset, which the Group has purchased and acquired based on a promise received from the customer to buy the item purchased according to specific terms and conditions. The selling price comprises the cost of the commodity and an agreed profit margin. DIB s Murabahat are mainly in commodities and vehicles. The bank is the leading provider of car loans in the UAE. Murabahat represented 45% of total loan portfolio and 40% of interest income in 2006. Istisna a is an agreement between the bank and a customer whereby the bank would sell to the customer a developed property according to agreed upon specifications. The group would develop the property either on its own or through a subcontractor and then hand it over to the customer against an agreed price. Istisna a represented 11% of the total loan portfolio and 6% of interest income in 2006. Ijara is an agreement whereby the bank purchases an asset for lease according to the customer s request, based on his promise to lease the asset for a specific period and against certain rent installments. Ijara represented 15% of the loan portfolio and 14% of interest income in 2006. Investing assets, which are mainly dominated by sukuk and mudarabat, represented 33% of the total loan portfolio in 2006. We estimate that current exposure to real estate in the bank s loan portfolio to be around 23% Loan portfolio has a high exposure to real estate We estimate that current exposure to real estate in the bank s loan portfolio to be around 23%, much higher than the average banking sector exposure of 11%. However, strong focus on Retail and Investment Banking business is expected to reduce the percentage contribution from real estate as the growth in the former two is expected to be faster. October 1st, 2007 11
An expected rise in loans to deposits is set to drive loans to grow at a CAGR of 22% Healthy liquidity provides room for aggressive loans growth The bank increased its loan portfolio by 24% in 2006 and by 29% in H1 2007 over H1 2006. We are bullish on the bank s ability to increase its loans on the back of a bullish outlook on the UAE economy and a healthy liquidity position at the bank. Loans to deposits ratio amounted to 74% in 2006 and we expect it to hover around 85% going forward. This implies loans to grow at a CAGR of 22% throughout the projection period. Loans 60.0% 85,000 50.0% 65,000 40.0% 45,000 25,000 30.0% 20.0% 10.0% 5,000 Dec/06 Dec/07 Dec/08 Dec/09 Dec/10 Dec/11 0.0% Loans (AED mn) Growth Source: DIB financials Loan Quality lower than the sector average NPL/gross loans stood at 3.5% in 2006 and is expected to decline to 3.0% in 2007. It is slightly higher than the average for the sector. Coverage ratio amounted to over 75% and we expect it to rise gradually to reach 85% by 2010. Wider credit spreads are expected to prevent yields from dropping at significant rates Yield on earning assets to benefit from widening credit spreads Yield on earning assets amounted to 6.2% in 2006 up from 4.8% in 2005. Higher yield resulted form higher rates across all earning assets including financing and investing assets. We expect yield on earning assets to remain flat in 2007. Although the US Federal Reserve has recently cut Federal Funds Target Rate by 50 bps, the UAE Central Bank has cut rates on CDs by 25 bps only. We don t see yield on earning assets to come down by the full 50 bps due to a widening of global credit spreads (the difference between government and corporate yields of similar maturity). We expect DIB, as well as other banks in the UAE, to take advantage of the widening in credit spreads by maintaining the current yield on earning assets despite lower interest rates. We are therefore factoring in a drop in DIB s yield of only 30 bps in 2008. Net interest income and interest spreads leading to wider interest spreads for DIB In H1 2007, DIB recorded a net interest income of AED 889 bn versus AED 482 bn in the same period last year, up 85% y-o-y. For the full year of 2007, we expect DIB to register net interest income of AED1.47 billion, up 34% y-o-y. Throughout our five years forecast horizon, we expect DIB s interest income to increase by CAGR of 24%. The strong forecasted growth in net interest income is to be driven by a strong growth in the balance sheet as well as improving interest spreads. Figures are in (AED000) FY06a H1 FY07a FY07 a FY08a Interest income 2,855,269 1,933,846 3,948,059 4,750,778 Interest expense 1,757,611 1,044,311 2,477,718 2,661,839 Net Interest Income 1,097,658 889,535 1,470,341 2,088,938 Interest spreads 2.41% NA 2.32% 2.62% Source: DIB, SHUAA Capital Interest spreads widened in 2006 by 50 bps on the back of a surge on the yield on earnings assets. We expect interest spreads to fall slightly in 2007 but record a recovery in 2008. The US Federal reserve has cut its Fed Funds Target rate by 50 bps. The UAE Central Bank followed by a 25bps cut on its CDs. A lower interest rate environment is expected to impact interest spreads for UAE banks positively. Cost of funds is expected to fall while October 1st, 2007 12
the yield on earning assets will show more resistance. Historically, interest rates and credit spreads have been negatively related. As credit spreads rise, banks are able to prevent lending rates from dropping while their deposit rates fall, resulting in higher interest spreads. Fees and commissions Fees and commissions fell significantly in H1 2007 due to a decline in IPO related income Down on lower IPO related income During H1 2007, DIB s fees and commissions amounted to AED379 million as opposed to AED444 in H1 2006. The fall in fees and commissions is due to the absence of substantial IPO funding income. Although the year 2007 has so far witnessed two large IPOs, (Air Arabia and Deyaar Development), the levels of oversubscriptions have been much lower than levels recorded in 2006. Major IPOs H1 FY06 Size (AEDmn) Oversubscription (X) Du 2,400 484 Tamweel 560 167 Major IPOs H1 FY07 Air Arabia 2,600 1.5 Deyaar 3,200 14 Source: SHUAA Capital The drop in fees and commissions is not specific to DIB and is actually a sector wide phenomenon. The chart below depicts the drop in the fees and commission among a sample of UAE s banks. 900,000 800,000 700,000 AED '000 600,000 500,000 400,000 300,000 200,000 100,000 0 NBAD ADCB UNB FGB DISB NBDD CBD MASB SIB RAKB UAB DIB ranked 3rd in the global Islamic bond league table by bookrunner in 2006. 1H FY06 Source: Banks financials 1H FY07 DIB is a leading manager of Sukuk globally Investment banking is an important contributor to DIB s fees and commissions representing 17% of total operating income in 2006. According to Dealogic, DIB ranked 3rd in the global Islamic bond league table by bookrunner in 2006, possessing 11.7% share of the global Islamic bond issuance market. In 2006, DIB co-managed, alongside with Barclays Capital, Nakheel sukuk issuance of USD 3.5 bn. The USD 3.5 bn sukuk issuance has been split equally between Dubai Islamic Bank and Barclays Capital in the league table above. It is worth noting that in 2005 DIB managed Dubai s Pots, Customs and Free Zone s sukuk issue of USD 3.5 bn. October 1st, 2007 13
Top 10 global sukuk managers USD mn Market share Malaysian Government Bond 2,702 18% CIMB 1,788 12% Dubai Islamic Bank 1,760 11.70% Barclays Capital 1,760 11.70% HSBC 1,479 9.80% AmMerchant Bank 1,293 8.60% Aseaambankers 839 5.60% Cagamas 592 3.90% Deutsche 460 3.10% RHB 392 2.60% Top 10 total 13,065 Top 20 total 15,038 Source: Dealogic and has ranked 5th in 2007 to date In 2007 to date, DIB has successfully retained its position as one of the top 5 sukuk managers in the world. It managed two sukuk issues for DIFC (USD 1.25 bn) and Dar Al Arkan (USD 1.0 bn). Top 5 global sukuk managers USD mn Market share September 2006 - September 2007 HSBC 4,800 15% CIMB 4,435 14% Malaysian Government Bond 3,687 12% Barclays Capital 3,353 11% Dubai Islamic Bank 2,255 7% Top 5 total 18,530 Top 20 total 31,396 Source: Dealogic It is apparent from the table above that the global Islamic sukuk market is set to more than double in 2007 and we expect DIB to take advantage from this growing global sukuk market. The said sukuk issuance is expected come through from companies operating in the oil, power, aviation, and real-estate sectors. It is worth noting that investment banking deals are primarily executed through the bank s subsidiaries, Millennium Capital (100% owned by DIB), and Millennium Finance (65% owned by DIB). Fees and Commissions (AED 000) FY06 a 1HFY07a FY07e FY08e Fess and commissions 855,434 379,006 863,988 924,467 % of operating income 44% 30% 33% 28% SourcE: DIB, SHUAA Capital Real estate Real-estate activity represents approximately 28% of DIB total operating income and includes income from Deyaar, income from investment properties and income from real estate financing. Real estate financing, which represented 9% of operating income in 2006, has been excluded from the analysis in this section as it has been included in the asset allocation section above. DEYAAR, DIB s real-estate arm Deyaar Development originally was the property management arm of Dubai Islamic bank and has subsequently developed into a full scale property development, leasing and services company. Deyaar s emergence as one of the leading developers in the UAE was coupled with a wider economic reform initiated by the UAE government at the October 1st, 2007 14
DIB s stake in Deyaar was diluted to 45% post Deyaar s IPO in 2007 We expect income from Deyaar to represent 10% of DIB s operating income in 2007 in addition to AED 617 mn from gain on the revaluation of Deyaar net asset value time. This included the introduction of new legislation on property ownership, allowing foreign ownership of property for the first time where 80% of the resident population is non-national, in addition to the introduction of accessible mortgage financing facilities to the market. The new policies drove unprecedented demand for property ownership. (Re: Deyaar Development, Initial Coverage September 9, 2007). In April 2007, Deyaar increased its capital by AED3.2 bn via an IPO. IPO proceeds will be used to acquire more land in its core markets (UAE, Lebanon, and Turkey) as well as in other emerging markets (Saudi Arabia, Qatar and India). Following the IPO, DIB s stake dropped from 100% to 45%. Starting from H2 2007, Deyaar will be no longer consolidated into DIB s financial statements and will be accounted for using the equity method. During 2006 and H1 2007, Deyaar recorded a bottom line figure of AED 412 million and AED 123 million respectively where both figures were fully consolidated in DIB s financials. We expect Deyaar to record a net income of AED 480 mn in 2007 where AED 284 mn will be recorded in DIB s financials representing 10% of the bank s operating income. The revaluation of Deyaar s assets and liabilities prior to the IPO resulted in a revaluation gain of AED969 million for DIB (AED 617 mn after deducting depositors share). DIB transferred its entire interest (100%) in Deyaar Development Company P.S.C to Deyaar Development PJSC as of May 30, 2007, for a total consideration of AED2.6 bn to be settled by the issue of 2.6 bn shares in Deyaar Development PJSC, giving DIB a 45% stake. The book value of Deyaar s shareholders equity at the time of the transfer amounted to AED1.6 bn, resulting in a gain of AED968 mn for DIB. The implied valuation for Deyaar s shareholders equity post IPO is AED5.8 bn. FY06 a H1FY07a FY07 FY08 Income from Deyaar (AED 000) 412,611 123,400 335,025 404,328 % of total operating income 15% 7.5% 7% 7% Source: DIB, SHUAA Capital Proprietary investments portfolio The proprietary investments portfolio includes the bank s investments in both the equity and the fixed income markets. Total investments amounted to AED3.34 bn in June 2007 versus 3.52 bn in FY06. Other associates Income from associates includes other companies in which DIB is currently holding a stake. In 2006 income from other associates registered a loss of AED 7.0 mn, while in H1 2007 it recorded an income of AED2.9 mn. We expect income from associates to increase significantly throughout our forecast horizon as most of associate investments are in their start-up phase. The table below depicts DIB associates. Tamweel is not accounted for as an associate as DIB stake in Tamweel is 19.9%, less than the 20% minimum required to be accounted for as an associate. Changes in the market value of DIB s stake in Tamweel impacts shareholders equity directly and does not impact the income statement. Associates Activity Country % of Equity Etislat International Pakistan Investments UAE 10% Bosnia International Bank Banking Bosnia 27.3% BBI leasing and Real-estate Real-estate Bosnia 27.3% Liquidity Management Center Brokers Bahrain 25% Emirates National Securitization Securitization Cayman Islands 35% Source: DIB October 1st, 2007 15
Efficiency The ongoing branch expansion plan which aims to increase the number of branches to 52 branches by the end of 2007 as opposed to 38 branches during the preceding period is totally reflected on DIB s efficiency ratio. During the H1 2007, cost to income ratio came in at 39%. We expect cost to income ratio to reach 33% in 2007 and hover around 35% throughout the projection period. Capital adequacy DIB s capital adequacy amounted to 16% in 2006, higher than the 10 % minimum as required by the Central Bank. We expect the bank to target a minimum capital adequacy of 14% going forward in order to sustain its strong credit ratings. As a result, we don t expect the cash dividend payout ratio to exceed 30% over the coming three years. Return We expect DIB s net income to increase by 55% to AED2.43 bn in 2007 5,000 4,000 We expect DIB s net income to increase by 55% to AED2.43 bn in 2007 versus AED1.56 bn in 2006. It is worth mentioning that DIB s expected bottom-line figure for 2007 is inflated by AED617 mn which represents gain on revaluation of transfer of the bank s stake in Deyaar Development. Throughout our forecast horizon, we expect DIB s net income to grow by CAGR of 22%. Excluding income from the transfer of DIB s stake in Deyaar, we expect DIB to record ROAE 2007E of 22.5% versus a sector average of 20%. Returns 29% 3,000 26% 2,000 1,000 23% 0 Dec/06 Dec 07E Dec 08E Dec 09E Dec 10E Dec 11E 20% Net income (AED mn) RoAE Source: DIB, SHUAA Capital October 1st, 2007 16
Valuation We initiate coverage on DIB with a Buy recommendation based on a target value of AED 10.58 per share We initiate coverage on Dubai Islamic Bank with a Buy recommendation based on a target price of AED 10.58 per share, implying an upside of 10.0% to the current market price of AED 9.62 per share. We used two valuation methods to estimate a value for DIB s equity, a discounted equity cash flow and a relative valuation. Value per share (AED) Weighting DECF 11.35 70% Relative valuation 8.76 30% Fair value 10.58 Source: SHUAA Capital Discounted equity cash flow (DECF) valuation We applied a sum of the parts DECF valuation for DIB whereby DIB s stake in Deyaar Development was valued separately from DIB s banking business. The value of DIB, excluding its stake in Deyaar Development, yielded a value per share of AED 9.62. 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. The cost of equity of 9.0% was based on a risk free rate of 5.5%, an equity risk premium of 5.0% and an industry beta of 0.7. The value of DIB s stake in Deyaar Development amounted to AED 1.74 per share. (Please refer to our Initiation of coverage on Deyaar Development dated September 5th, 2007). The DECF method resulted in a value per share for DIB of AED 11.35. Relative valuation The relative valuation for DIB resulted in a relatively wide valuation range (AED 7.40 for the PB relative valuation and AED 9.49 for the PE relative valuation). Both methods suggest that DIB is trading at a premium to its target value. The average of the two relative valuation methods suggest a target value for DIB of AED 8.76 per share. A possible explanation to the valuation differential between the relative valuation and the DECF is the fact that the relative valuation is solely dependant on the bank s expected operational profitability in 2007, while the DECF method is capturing the bank s aggressive branch expansion plan and increasing demand for Islamic banking products over the next five years. PB relative valuation The price to book relative valuation is based on a regression of the price to book multiple of a peer group against RoAE 2007E. The peer group includes eight Islamic banks in the GCC. Based on the derived regression equation, the relative valuation of DIB resulted in a value per share of AED 7.40. It is important to note that the valuation was based on DIB s RoAE 2007E of 22.5% after adjusting for non recurring items. 6 5 KFH Al Rajhi P/BV 4 3 2 ADIB DIB BIB QIB Jazira QIIB 1 Al Baraka 0 16% 21% 26% ROAE 31% 36% Source: Banks financials, SHUAA Capital (Note: Islamic Banks used in the regression include Al Rajhi Bank, Bank Al Jazira, Abu Dhabi Islamic Bank, Qatar Islamic Bank, Qatar International Islamic Bank, Al Baraka Banking Group, Bahrain Islamic Bank and Kuwait Finance House). October 1st, 2007 17
PE relative valuation The PE relative valuation has indicated that DIB is currently trading at a slight premium to its target value. We used Kuwait Finance House and Al Rajhi Bank as peers for DIB. Similar to DIB, each of the two banks is the largest Islamic Bank in its country. Kuwait Finance House PE 2007E 21.33 Kuwaiti conventional banks PE 2007E 14.90 Premium 43% Al Rajhi Bank PE 2007E 17.94 Saudi conventional banks PE 2007E 13.80 Premium 30% Dubai Islamic Bank PE 2007E 15.49 UAE conventional banks PE 2007E 11.15 Premium 43% DIB Target premium 37% DIB Target PE 2007E 15.23 DIB Implied Target value per share (AED) including AED 0.2 per share (AED 617 mn Deyaar revaluation gains) 9.49 October 1st, 2007 18
Financials INCOME STATEMENT AED 000 Year to December 2006 2007E 2008E 2009E 2010E 2011E Interest income 2,855,269 3,948,059 4,750,778 5,510,092 6,283,161 6,948,779 Interest expense -1,757,611-2,477,718-2,661,839-3,102,208-3,505,430-3,785,730 Net interest income 1,097,658 1,470,341 2,088,938 2,407,884 2,777,731 3,163,048 Net fee and commission income 855,434 863,988 993,586 1,142,624 1,256,887 1,382,575 Net gains from FX transactions 36,904 37,273 59,637 83,492 116,888 163,644 Dividends income 39,028 52,859 54,114 56,773 59,698 62,916 Investment gain 72,388 812,127 147,250 146,761 146,606 154,507 Income from Deyaar 412,611 283,980 291,958 476,177 614,221 638,896 Other income 49,301 157,294 180,888 198,976 218,874 240,761 Income from associates 16,148 21,558 109,946 181,411 278,163 335,465 Income from investment properties 153,203 247,394 312,097 327,702 344,087 361,292 Total non-interest income 1,635,017 2,476,473 2,149,476 2,613,917 3,035,425 3,340,055 Total income from operations 2,732,675 3,946,814 4,238,414 5,021,801 5,813,155 6,503,104 Staff and general expenses -1,065,055-1,256,765-1,495,551-1,794,661-1,920,287-2,054,707 Total provision charge -76,467-215,081-213,574-224,806-282,470-156,113 Depreciation -10,240-12,838-14,335-16,760-19,262-21,753 Total non-interest expenses -1,151,762-1,484,685-1,723,460-2,036,227-2,222,019-2,232,573 Profit before tax 1,580,912 2,462,130 2,514,955 2,985,574 3,591,137 4,270,530 Taxes -3,069-12,311-12,575-14,928-17,956-21,353 Minority Interest -17,750-24,621-25,150-29,856-35,911-42,705 Net profit 1,560,093 2,425,198 2,477,230 2,940,790 3,537,270 4,206,472 Source: DIB, SHUAA Capital October 1st, 2007 19
Balance Sheet AED 000 Year to December 2006 2007E 2008E 2009E 2010E 2011E Cash & Central Bank 3,111,724 3,691,002 5,295,951 7,678,337 6,670,344 6,458,957 Fixed Income Investments 14,991,239 15,385,689 17,881,958 17,671,997 19,334,557 20,094,709 Investments in Associates 1,077,901 1,099,459 1,209,405 1,390,816 1,668,979 2,004,444 Investments in Deyaar 3,000,413 3,292,372 3,768,549 4,382,770 5,021,666 Equity Investments (Trading) 3,523,944 3,681,238 3,862,125 4,061,101 4,279,975 4,520,737 Due from Banks 407,245 568,602 674,342 751,060 887,811 889,239 Loans & advances (net of provisions) 35,255,447 53,515,440 63,685,632 75,105,988 86,808,214 94,154,717 Investment properties 897,798 1,217,941 1,278,838 1,342,780 1,409,919 1,480,415 Fixed assets 2,666,605 662,955 782,287 907,453 1,034,497 1,158,637 Other assets 2,465,123 2,390,789 2,629,868 2,695,615 2,712,462 2,716,701 Goodwill 36,910 36,910 36,910 36,910 36,910 36,910 Total assets 64,433,936 85,250,438 100,629,687 115,410,606 129,226,438 138,537,129 Customer deposits 47,732,482 66,894,300 79,334,328 88,359,985 98,645,698 104,616,352 Due to banks 4,649,900 3,010,244 3,570,045 3,976,199 4,439,056 4,707,736 Long term loans 0 2,754,750 2,754,750 5,509,500 5,509,500 5,509,500 Other liabilities 3,227,304 3,110,075 3,421,083 3,763,191 4,139,510 4,553,461 Total liabilities 55,609,686 75,769,369 89,080,205 101,608,876 112,733,764 119,387,048 Minority Interest 287,100 311,721 336,871 366,727 402,638 445,343 Share capital 2,800,000 2,996,000 2,996,000 2,996,000 2,996,000 2,996,000 Reserves 3,973,304 4,154,124 4,401,847 4,695,926 5,049,653 5,470,300 Retained earnings 43,197 1,040,607 2,551,718 4,316,192 5,907,963 6,749,258 Cumulative Change in Fair Value 544,649 544,649 544,649 544,649 544,649 544,649 Total shareholders equity 7,361,150 8,735,380 10,494,214 12,552,767 14,498,265 15,760,207 Proposed dividends 1,176,000 433,967 718,397 882,237 1,591,771 2,944,531 Total liabilities and equity 64,433,936 85,250,438 100,629,687 115,410,606 129,226,438 138,537,129 Source: DIB, SHUAA Capital October 1st, 2007 20
Key Ratios Year to December 2006 2007E 2008E 2009E 2010E 2011E Growth Total equity 136.0% 25.0% 19.1% 18.8% 14.9% 8.4% Total assets 46.3% 37.4% 17.7% 14.6% 11.9% 7.2% Total loans 24.6% 51.8% 19.0% 17.9% 15.6% 8.5% Customer deposits 42.9% 40.1% 18.6% 11.4% 11.6% 6.1% Earning assets 41.3% 37.3% 18.4% 13.6% 14.3% 7.5% Funds 39.7% 38.7% 17.9% 14.2% 11.0% 5.7% Capital Adequacy Equity / assets 11.8% 10.7% 10.8% 11.2% 11.5% 11.7% Tier 1 Capital / RWA 16.7% 14.0% 14.0% 14.3% 14.3% 14.3% Asset Quality NPL / Gross Loans 3.5% 3.0% 2.8% 2.6% 2.5% 2.5% LLP / NPL 73.6% 70.0% 75.0% 80.0% 85.0% 85.0% Margins & profitability Interest Spread 2.406% 2.323% 2.623% 2.614% 2.601% 2.603% Net interest Margin 2.429% 2.341% 2.632% 2.620% 2.651% 2.728% RoAE 29.8% 29.3% 24.6% 24.5% 25.3% 27.0% RoAA 2.97% 3.27% 2.65% 2.71% 2.88% 3.13% Liquidity Loans / Deposits 73.9% 80.0% 80.3% 85.0% 88.0% 90.0% Efficiency Cost/income 39% 32% 36% 36% 33% 32% Source: DIB, SHUAA Capital October 1st, 2007 21