October 06, 2009 Fair Value Estimate: AED 3.52 Recommendation: Hold Executive Summary (DIB) reported a strong 21.6% q-o-q increase in net profit to AED 450mn in Q2 2009 reflecting improved results from both core and non-core banking business. However, we expect sharply lower net profits in the third quarter due to weaker asset yields and a forecast increase in loan loss provisioning. For Q3 2009, we anticipate a 35% decline in net profit to around AED 295mn, compared to Q2. NII increased by only 6.6% q-o-q to AED 570mn in Q2 although Net Fee & Commission Income rose strongly by 18.5% q-o-q to AED 209mn. For Q3, we forecast lower NII and Fee & Commission Income due to weaker asset yields and slower business activity over the summer, respectively. DIB s cost-to-income ratio fell from 41.5% in Q1 2009 to 35.1% in Q2 2009 although we expect it to increase in the short to medium term due to expansion of the Bank s branch network. DIB maintained a conservative balance sheet with Islamic Financing and Investing assets declining 1.1% q-o-q to AED 61.9bn and deposits 6.6% q-o-q to AED 71.5bn. Nevertheless, we expect both the loan book and deposit base to recover following improvements in the macroeconomic environment. Loan loss provisions increased 30% q-o-q to AED 135mn in Q2. Given the Bank s substantial exposure to the Dubai real estate sector, we expect a continued near-term increase in provisions including a further provision of AED 180mn in Q3 2009. Valuation: Following DIB s Q2 2009 results recovery from the low base of Q4 2008 and Q1 2009, we have increased our estimates. Our valuation model now indicates a fair value of AED 3.52, implying an upside potential of 11.7% from the current market price of AED 3.15. Following a substantial increase in the Bank s share price since our last report, we downgrade our rating from Buy to Hold. RESULT UPDATE Share Data Market Cap AED 11.4bn Price AED 3.15 DFM Index 2,236.5 Reuters DISB.DU Bloomberg DIB:UH Avg. Volume (52 Week) 11.6mn 52-Week High/Low AED 5.69 / 1.38 Diluted Shares Outstanding 3,617.5mn Fair Value Estimate AED 3.52 Rating HOLD Key Figures Year to 31 Dec 2008A 2009E Net Intermediation income (mn) 2,145.9 2,148.5 Total operating Income (mn) 3,668.7 3,414.1 Net Profit ex. one-off (mn) 1,730.3 1,402.5 EPS (AED) 0.48 0.39 EPS growth (24.4)% (18.9)% NIM (%) 2.9% 2.8% RoA (%) 2.0% 1.6% RoE (%) 17.6% 15.8% P / E (x) 6.6x 8.1x P / BV (x) 1.3x 1.3x Shareholding Pattern (%) Investment Corporation of Dubai 30.5% Saeed Ahmad Lootah 7.2% Public 62.3% Relative Performance 8.0 6.0 4.0 2.0 0.0 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 DIB Reba sed Index ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 1
Investment Rationale DIB reported a strong 21.6% q-o-q increase in net profit to AED 450mn in Q2 2009, 17.3% above our forecast, due to higher Net Intermediation Income (NII), the positive effects of prudent cost control measures and lower loan loss provisioning. However, the balance sheet position remained conservative with Islamic Financing and Investing assets declining 1.1% q-o-q to AED 61.9bn and deposits 6.6% q-o-q to AED 71.5bn. Nevertheless, we regard as positive DIB s strategic re-focus on strengthening its retail banking business, which it expects to expand with the addition of seven new branches in UAE by the end of this year. The Bank expects it s customer base to expand by 15% to around 900,000 customers and retail assets growth of approximately 20% by year end according to management guidance. We have increased our forecasts to reflect the Bank s better than expected results and improving macroeconomic conditions. Consequently, we raise our target price from AED 3.07 to AED 3.52. However, following a sharp increase in the share price our valuation only implies a potential upside of around 11.7% from the current market price of AED 3.15. We therefore downgrade our rating from Buy to Hold. Profitability will probably decline in Q3 In Q2 2009, the Bank s net profit increased 21.6% to AED 450mn reflecting improved results from both core and non-core banking businesses. However, we expect sharply lower net profits in the third quarter due to weaker asset yields and a forecasted increase in loan loss provisioning. For Q3 2009, we anticipate a 35% decline in net profit to around AED 295mn, compared to Q2. During Q2 2009, the Bank s NII increased by 6.6% q-o-q to AED 570mn, largely due to a lower depositor share of profit which declined 9.5% q-o-q to AED 449mn. However, for Q3 2009, we expect NII to fall by around 7% to AED 531mn mainly as a result of weaker asset yields. Net Fee and Commission Income increased strongly by 18.5% q-o-q to AED 209mn in Q2 due to improvements in the macroeconomic environment. However, given the seasonal slowdown in business activity during the summer months, we expect net fee and commission income to fall by around 19% q-o-q to AED 170mn in Q3 2009. DIB s cost-to-income ratio, one of the highest in the industry, declined from 41.5% in Q1 2009 to 35.1% in Q2 2009, reflecting prudent cost control measures. For Q3 2009, we expect the cost-to-income ratio to increase sharply to around 43% due to an expected fall in operating income the Bank expanding its UAE branch network from 57 currently to 64 by year end, and an expected. Loan loss provisions increased by a substantial 30% q-o-q to AED 135mn in Q2, reflecting the lag effect of adverse macroeconomic conditions. We forecast an increased charge for provisions in Q3 2009 resulting from higher NPLs expected during the period. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 2
However, we now expect a gradual improvement in both the loan book and deposits Given the current difficult macroeconomic environment, DIB has maintained a very conservative balance sheet position in recent quarters. Islamic Financing and Investing assets declined 3.1% in H1 2009 to AED 61.9bn, compared to 2008. However, given improved business conditions and the Bank s renewed focus on growth, we expect Islamic Financing and Investing assets to increase by around 5% to AED 65.2bn in Q3. Similarly, customer deposits, which declined 6.6% sequentially in Q2, are likely to improve based on significantly improved liquidity conditions. We expect deposits to increase by 1.7% to AED 72.8bn in Q3 driven by an expected larger customer base and branch network. DIB s Capital Adequacy Ratio (CAR) remained sound at 12.4% as of 30 June 2009, compared with 11.7% in Q1 2009 and 11.1% at the end of 2008. The Bank plans to raise AED 3bn in capital by rights issue over a period of five years which we believe will strengthen the balance sheet sufficiently to finance its strong future growth as market conditions improve. Asset quality remains a cause for concern We remain concerned at the Bank s low coverage ratio at 55.9% at the end of 2008. Given its large exposure to the real estate sector, we believe NPLs will increase in the short to medium term and forecast an NPL ratio of 5.2% at the end of Q3 2009, compared with 3.7% at the end of 2008. We therefore expect a continued near-term increase in provisions including a further AED 180mn in Q3 2009. Valuation We have valued using a combination of Discounted Equity Cash Flow (DECF) and Peer-Based Multiples. We have assigned subjective weights of 70% to our DECF and 30% to our Peer-based Multiple Valuations to calculate our fair value estimate for the standalone entity. We have separately valued investments in properties, properties held for sale, and investment in associates at 0.5x their book value. Our DECF valuation has been assigned a higher weight as it discounts firm-specific cash flows. These valuation models yield a fair value of AED 3.52 per share for the consolidated entity, representing a premium of 11.7% to the current share price. A significant proportion of this valuation is generated by the standalone banking entity (valued at AED 2.53 per share), with the remainder (AED 0.99) comprising Investment in properties and associates. We downgrade our rating on the stock from Buy to Hold. Weighted Average Value per Share Valuation Method Value (AED) Weight (%) Discounted Equity Cash Flow (DECF) 1.99 70% Peer-based multiple valuation 3.79 30% Weighted Average Standalone Fair Value 2.53 100% Investment in properties, properties held for sale, & asso 0.99 Total Fair Value 3.52 Source: ADCB research ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 3
We have used a two-stage DECF model with explicit forecasts to 2016. Based on these, we have calculated free cash flows which we have then discounted in order to estimate the fair value of the Company. We have estimated the Cost of Equity using the Capital Asset Pricing Model. The key assumptions underlying our model are as follows: Risk free rate: 4.12% Equity Risk Premium: 6.0% Country Risk Premium: 2.9% Beta: 1.19 Cost of equity: 14.16% Terminal growth rate: 3.5% Based on these assumptions, our estimate of the fair value of equity for DIB is AED 7.2bn. There are 3.6 billion diluted outstanding shares. On this basis, our DCF model yields a fair value per share of AED 1.99. Sensitivity of fair value estimate, using different rates for terminal cost of capital and terminal growth rates: Terminal growth Source: ADCB research Terminal cost of equity 2.0 13.16% 13.66% 14.16% 14.66% 15.16% 2.50% 2.1 2.0 1.9 1.8 1.7 3.00% 2.1 2.0 1.9 1.8 1.8 3.50% 2.2 2.1 2.0 1.9 1.8 4.00% 2.3 2.2 2.1 2.0 1.9 4.50% 2.4 2.2 2.1 2.0 1.9 Using our peer-based multiples valuation, our analysis yields a fair value per share of AED 3.79. Comparable Trading Analysis Company P/E P/BV RoE 2008A 2009E 2008A 2009E 2008A 2009E Al Rajhi 17.2x 16.6x 4.2x 4.0x 25.8% 24.5% Riyad Bank 17.0x 18.2x 1.7x 1.7x 13.6% 9.4% Qatar Islamic Bank SAQ 11.4x 11.4x 2.6x 2.5x 27.9% 22.4% Abu Dhabi Islamic Bank 7.3x 6.8x 1.1x 1.1x 18.8% 15.9% Sharjah Islamic Bank 11.7x 4.8x 0.6x 0.7x 7.3% 13.6% Mean 12.9x 11.6x 2.1x 2.0x 18.7% 17.2% Median 11.7x 11.4x 1.7x 1.7x 18.8% 15.9% Source: Company data, Reuters ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 4
Income Statement Balance Sheet (AED mn) Q109 Q209 Q309E Q409E Q109 Q209 Q309E Q409E Income from Islamic financing 1,030 1,018 899 855 Cash & balances with other banks 16,454 10,869 11,206 9,872 Depositors share of profits 496 449 369 341 Islamic fin. & intl. murabahat 66,810 65,448 68,769 67,286 Investments & others 8,970 9,088 9,117 9,176 Net Intermediation income 534 570 531 514 Property & Equipment, net 673 703 733 766 Other Income 276 347 312 332 Other Assets 1,944 1,757 1,849 1,811 Total Assets 94,850 87,865 91,675 88,911 Total Operating Income 810 917 842 845 Operating Expense 336 322 363 377 Customer Deposits 76,629 71,536 72,779 70,464 Financing obligation 5,170 3,605 5,709 5,641 Pre-Provisioning Profit 474 595 479 468 Other Liabilities 4,665 3,830 3,996 3,875 Provisions 104 135 181 184 Total Liabilities 86,465 78,971 82,484 79,980 Share Capital 3,618 3,618 3,618 3,618 Profit Before Tax 370 459 298 284 Reserves & Surplus 4,768 5,274 5,569 5,307 Tax (0) 6 1 1 Minority Interest 0 3 5 6 Net Profit 370 453 296 283 Total Equity & Liabilities 94,850 87,865 91,675 88,911 Income Statement Key Ratios (AED mn, Yr. ending Dec. 31) FY07A FY08A FY09E FY10E FY07A FY08A FY09E FY10E Income from Islamic financing 3,881 4,022 3,803 3,663 Per share data (AED) Depositors share of profits 2,395 1,876 1,654 1,492 Shares outstanding (mn) 2,996 3,618 3,618 3,618 Net Intermediation income 1,486 2,146 2,148 2,170 EPS (pre-exceptional) 0.63 0.48 0.39 0.38 YoY Growth (%) 40.5% 44.4% 0.1% 1.0% DPS 0.33 0.25 0.15 0.10 Other Income 2,203 1,523 1,266 1,521 Book value per share 3.5 2.5 2.5 2.7 Total Operating Income 3,688 3,669 3,414 3,691 YoY Growth (%) 30.8% (0.5%) (6.9%) 8.1% Valuation ratios (x) Operating Expense 1,505 1,420 1,398 1,534 P/Pre-provisioning Profit 4.3x 5.1x 5.7x 5.3x Pre-Provisioning Profit 2,183 2,249 2,016 2,157 P/E 5.0x 6.6x 8.1x 8.4x Provisions 301 521 605 793 P/B 0.9x 1.3x 1.3x 1.1x Non recurring items 617 - - - Profit Before Tax (ex. one-off) 1,882 1,728 1,411 1,364 Performance ratio (%) Tax (14) (2) 9 7 Return on average assets 2.6% 2.0% 1.6% 1.4% Net Profit (ex. one-off) 1,896 1,730 1,403 1,357 Return on average net worth 20.8% 17.6% 15.8% 14.3% YoY Growth (%) 21.5% (8.7%) (18.9%) (3.2%) Yield 6.3% 5.4% 4.9% 4.4% Net Profit (incl. one-off) 2,513 1,730 1,403 1,357 Cost of funds 4.9% 3.2% 2.7% 2.3% Spread 1.4% 2.2% 2.3% 2.1% Balance Sheet NIM 2.4% 2.9% 2.8% 2.6% Cash & balances with other banks 6,101 8,170 9,872 14,315 NPL to gross loans 3.5% 3.7% 5.7% 6.1% Islamic fin. and intl. murabahat 65,326 65,526 67,286 74,797 Investments & others 9,991 8,995 9,176 8,847 Balance Sheet ratios (%) Property & Equipment, net 631 669 766 1,139 Islamic fin. & intl. murabahat growth 30.0% 0.3% 2.7% 11.2% Other Assets 2,311 1,672 1,811 2,009 Deposits growth 36.5% 1.9% 6.1% 14.6% Total Assets 84,360 85,031 88,911 101,107 Advances to deposit 75.3% 96.2% 90.6% 87.7% Investments (% of deposit) 15.3% 13.5% 13.0% 11.0% Customer Deposits 65,176 66,427 70,464 80,783 Liquid assets (% of assets) 7.2% 9.6% 11.1% 14.2% Financing obligation 4,996 6,086 5,641 5,991 Other Assets (% of assets) 2.7% 2.0% 2.0% 2.0% Other Liabilities 3,523 3,593 3,875 4,407 Borrowings (% of advances) 10.2% 9.5% 8.8% 8.5% Total Liabilities 73,695 76,106 79,980 91,180 Capital Adequacy ratio 13.1% 10.7% 16.9% 15.9% Share Capital 2,996 3,618 3,618 3,618 Reserves & Surplus 7,418 5,308 5,307 6,295 Operating ratios (%) Total Shareholders' Equity 10,414 8,925 8,925 9,912 Operating cost to operating income 40.8% 38.7% 40.9% 41.6% Minority Interest 251 0 6 14 Operating cost to net income 79.4% 82.0% 99.7% 113.0% Total Equity & Liabilities 84,360 85,031 88,911 101,107 Operating cost to avg. assets 2.0% 1.6% 1.6% 1.6% Source: Company data, ADCB research ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 5
Investment Ratings: Buy: More than +15% potential return. We recommend that investors buy the stock based on the annualised return to the shareholders over 6-24 months time horizon (percentage change from current price to the projected target price). Hold: Between +15% and -15% potential return. We take a neutral view on the stock over the 6-24 months period. Sell: Less than -15% potential return. We recommend that investors sell the stock based on the annualised return to the shareholders over the 6-24 months time horizon. Other Disclosures: Abu Dhabi Commercial Bank (ADCB) publishes independent research based on its own opinions and does not have investment banking relationships with any firm whose security is mentioned in this report. ADCB does, however, hold securities of the firm mentioned in this report through its fund management activities. If you choose to use the information in this report, you do so on your own initiative, and you are responsible for compliance with any applicable local laws. ADCB certifies that no part of the research analyst s compensation was, is, or will be, directly or indirectly, related to the specific recommendations or view expressed in this research report. The information and opinions in this report were prepared by employees of ADCB and are current as of the date of the report. The information contained herein has been obtained from sources that they believe to be reliable, but ADCB does not guarantee its accuracy, adequacy, completeness, reliability, or timeliness. Moreover, it is not responsible for any errors or omissions or for the results obtained from the use of such information. All opinions and estimates included in this report are subject to change without notice. ADCB will furnish, upon request, available investment information supporting this recommendation. This report is intended for qualified customers of ADCB. This research report provides general information only. Neither the information nor any opinion expressed constitutes an offer or an invitation to make an offer, to buy or sell any securities or other investment or any options, futures or derivatives related to such securities or investments. It is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realised. Investors should note that income from such securities or other investments, if any, may fluctuate and that price or value of such securities and investments may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. Any information relating to the tax status of financial instruments discussed herein is not intended to provide tax advice or to be used by anyone to provide tax advice. Investors are urged to seek tax advice based on their particular circumstances from an independent tax professional. Foreign currency rates of ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 6
exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk. To the fullest extent permitted by law, neither ADCB nor any of its employees will be liable to you or anyone else under any tort, contract, negligence, strict liability, products liability, or other theory with respect to this presentation of information. You may not redistribute this report without explicit permission from ADCB. ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 7
ADCB Research Team: Khaled Akl, MBA, CFA Head of Research Khaled.A2@adcb.com +9712 696 2843 Sami Benghezal,M.Sc, FRM,CFA Research Manager sami.b2@adcb.com +9712 697 3525 Jehad Saeed Al Mazrooei Research Analyst Jehad.s@adcb.com +9712 697 3522 Rakesh Kumar Agarwal, MBA Research Analyst Rakesh.k@adcb.com +9712 697 3685 Mohamed Junaid Bray, CFA Research Analyst Mohamed.J3@adcb.com +9712 697 3461 ADCB Wealth Management Group I Research I +97126973525 ADCBresearch@adcb.com 8