United Bank Limited Improving fundamentals already priced in! Wednesday November 13, 2013 NEUTRAL Target Dec 14: PKR 133 Current Price: PKR 127 Bloomberg Reuters UBL.PA UBL.KA MCAP (USD mn) 1,443 12M ADT ( USD mn.) 1.0 Shares Outstanding 306 Valuations 2012A 2013F 2014F EPS 14.7 14.5 16.4 DPS 8.5 8.5 9.5 CY14F Dividend Yield (%) 7% Capital Gain (%) Total Gain (%) 11% UBL vs. KSE100 Relative Chart 200 180 160 140 120 100 80 Nov 12 Dec 12 KSE100 Index Jan 13 Mar 13 Feb 13 Apr 13 May 13 Jul 13 Jun 13 Aug 13 Sep 13 UBL Oct 13 UBL Profile: UBL is engaged in commercial banking and related services. The bank operates over 1,200 branches inside Pakistan including 14 Islamic Banking branches, making it the third largest bank in Pakistan. The bank also operates 17 branches outside Pakistan. UBL s GDRs are traded at London Stock Exchange. The bank was established in 1959 as a local private sector bank but was nationalized in 1974 by the GoP. It was sold off to a consortium of Abu Dhabi Group of UAE and Bestway Group in 2001 under a privatization program. Nov 13 Investment Thesis We resume our coverage on banking sector with United Bank Limited (UBL) with a target price of PKR133/sh, offering an upside potential of along with DY14E of 7% within banking space, maintaining our Neutral stance on the stock. On last close, the bank is trading at Dec14E PBV and PER of 1.7 and 7.8 respectively. Though at current levels, the scrip doesn t excite us in terms of total return however any major dip in the market price can originate a fair buy call. Improving fundamentals to support valuations! We believe recent increase in policy rate by 50bps (Sep13) has marked a reversal in interest 7ate cycle thus improving already depressed margins going forward. However, this increase in margins will be partially offset by recent pegging of MDR with repo rate by SBP which will ultimately increase cost of funds. Thus, banks with higher current account to total deposit ratio will be the biggest beneficiary in rising interest rate environment. With 33% in current account, UBL is likely to recover its margin to 5.8% in 2014E (from 5. in 2013E). We believe, competition in banking sector will remain fierce going forward, restricting UBL s market share in total deposits to 11% in the long run. With this market share, total deposits is likely to post a growth of 1 in 2013 18E (5yr CAGR). We believe incremental deposits will be skewed evenly towards advances and investments. In order to further improve asset quality, the bank has decided to opt a stringent credit policy framework consequently, bank s infection ratio declined to 12. in Sep13 from 14. in Dec12. We believe asset quality ratios will further improve on the back of vigilant credit policy, strong recoveries and improving credit profile of overseas loans. Rising Non core Income to strengthen overall earnings: We believe, the bank will remain favorable franchise for fee and commission based business because of its deep rooted presence in the segment coupled with bank s efforts to retain its ascendancy in branchless banking. Going forward, we believe that bank will see a healthy contribution from Omni (branchless banking) in non core income. Strong International banking profile: On the back of improved earnings from overseas branches, it is turning out to be one of the unique selling propositions for the bank as it currently operates 18 international branches(third highest in top tier banks). We believe earning from overseas will improve further because of higher growth prospects of UAE (as per IMF forecast) which share 6 of overseas advances. Valuation: We prefer Dividend Discount Method (DDM) and Residual Income Valuation Method (RIVM) for valuing UBL and Pakistan Banks and average of these matrices derive our fair value for the scrip. Based on above techniques, Dec14 TP is at PKR133/sh, offering an upside potential of. Furthermore, we assume the bank to maintain payout ratio ~58% going forward. Thus, the scrip also offers dividend yield of 7%. Iqbal Ismail Dinani Iqbal.dinani@bmacapital.com +92 111 262 111 Ext: 2059 or sell the securities mentioned. 1
We resume our coverage on banking sector with United Bank Limited (UBL) Dec14 TP of PKR135/sh, offering an upside potential of along with DY14E of 8% within banking space. At last close, UBL is trading at Dec14E PBV and PER of 1.7 and 7.8 respectively. Though at current levels, the scrip doesn t excite us in terms of total return however any major dip in the market price can originate a fair buy call. Improving fundamentals to support valuations Thorough examination of UBL financials and discussion with the company management, we see an inherent potential to excel because of strong domestic branch network, vigilant credit policy framework, dominance in branchless banking and progressive international banking business. 1) Monetary tightening to unleash earnings growth Monetary tightening is likely to expand NIMs Recent increase in policy rate by 50bps (Sep13) has marked a reversal in interest rate cycle on the back of rising inflationary expectations. That said, higher interest rate is likely to expand already oppressed NIMs (6.3% in Sep13 down from 6.9% in Sep12) of the banking sector. We believe banks with higher current account to total deposit ratio will be the biggest beneficiary in rising interest rate environment. Though, UBL stands at a quiet lower level in terms of this ratio (2 nd to last in top tier banks) limiting its NIMs expansion potential, the policy rate uptick will lead the bank to recover its spreads to 5.8% in 2014 (5. in 2013E). Furthermore, inculcating tight monetary stance from 2014 2018, UBL is likely to increase in earnings by 11% CAGR (5yr). Comparison of top tier banks (Current account to total deposit) as of Sep13 5 Current account to Deposits 45% 47% 4 3 33% 3 3 2 1 UBL MCB HBL NBP ABL * *NBP as of Jun13 Source: BMA Research though partially offset by MDR pegging with Repo rate The banking sector is prone to high regulatory risk which has a great influence on sector s profitability. Recently, SBP has linked minimum deposit rates (MDR) on savings account (50bps lower than repo rate) to repo rate thus increase in discount rate will have a respective increase on MDR offered savings account holders. Had this not been linked, UBL s earnings during 2014 would have been high by PKR3.7/sh (19%). We believe that bank will shift its focus on generating low cost deposits in order to reduce above cited impact. or sell the securities mentioned. 2 1
Decline in EPS (PKR) due to MDR pegging with repo rate 40 EPS With MDR measure EPS Impact 35 30 5.8 6.6 25 5.4 5.1 20 15 10 5 3.7 16.4 21.2 22.8 27.2 28.2 0 2014 2015 2016 2017 2018 Source: BMA Research 2) Strong balance sheet growth; unlocking lending/investing appetite The bank s strategy to capitalize its widespread branch network has translated into a decent increase in deposits by 1 (4yrs CAGR) during 2008 2012. However, due to aggressive domestic competition, its market share decline from 12.7% in 2008 to 10.5% in 2012. We believe, competition in banking sector will remain fierce going forward, restricting UBL s market share to 11% in the long run. With this market share, total deposits is likely to post a decent growth of 1 in 2013 18E (5yr CAGR). We believe deposit will be evenly routed to ADR (51%) and IDR (49%) going forward. 3) Vigilant credit/investing policy framework to improve overall asset quality Weak macro economic situation coupled with unabated structural issues have dampened overall banking industry s credit profile. Resultantly, overall infection ratio of banking sector peaked to 17.5% in 2011 which then improved to 1 in Sep13. Following general industry trend, the bank s infection ratio reached to 1 in 2011 which improved considerably to 12. in Sep13. This improvement in infection ratio is attributed to 1) stringent policies for issuing new loans (consumer lending decline to 1 of total advance in 2012 from 23% in 2007) and 2) focusing more on recoveries. We expect the bank to continue stressing on tight credit policies for retaining infection ratio to 1 13% going forward. Coverage ratio has improved to 85% in Sep13 as compared to 78% in Dec12. However, conservatively we have assumed a coverage ratio of 80 8 (2013 2018), still higher than 2011 leaves as bank will continue to distant itself from fresh lending. Improving asset quality in overseas advances also Infection ratio of the overseas advances reduced to 6. in Sep13 as compared to 8.3% in 2012 alongside coverage ratio of 7 in Sep13 from 6 in 2012. This improvement in asset quality ratios in the overseas advances is primarily due to rapid economic recovery in ME region and we expect it to further improve on the wake of economic recovery in the region particularly UAE (chart: IMF growth prospects). or sell the securities mentioned. 23
Declining infection ratio with higher provision coverage of overseas loans 1 9% 8% 7% 5% 3% 1% Infection Ratio (LHS) Coverage (RHS) 1Q CY12 2Q CY12 3Q CY12 4Q CY12 1Q CY13 2Q CY13 3Q CY13 8 7 6 5 4 3 2 1 Strong International banking profile Offshore banking provides an angle of diversification, a hedge against rising domestic competition and exchange gains from PKR depreciation. On the back of decent earnings from overseas branches, it is turning out to be one of the unique selling propositions for the bank as currently it operates 18 international branches (third highest in top tier banks) while its foreign currency loans to total loans stands at (highest amongst top tier banks). ROA lags amongst top tier banks UBL s offshore earnings (PBT) to average assets employed lags among top tier banks as the bank posted return of 1.7% in 2012, way behind 5.3% of ABL (2 branches) and 4.1% MCB (8 branches) though both of these competitor banks have limited number of branches when compared with UBL (18 branches). Furthermore, YoY analysis reveals that UBL earnings from offshore branches have been consistently declining because of dwindling economic activity in ME region particularly UAE (2008 12) which contributes to 6 of total overseas advances and higher operating expenses. Top tier banks Int. branches and ROA Declining ROA and share in total earning 5% 3% 1% Branches (RHS) ROA (LHS) 50 45 40 35 30 25 20 15 10 5 0 UBL ABL NBP HBL MCB BAFL 3% 3% 1% 1% 18% Share (RHS) ROA Domestic (LHS) ROA Overseas (LHS) 1 1 13% 2009 2010 2011 2012 2 18% 1 1 1 1 8% or sell the securities mentioned. 3 4
but post an opportunity to excel amid economic growth Driven by economic recovery in ME and African region, we anticipate these branches to bear fruits in growing economic environment. Around 6 of overseas advances are tied in UAE where a higher growth prospect (as per IMF growth targets) is expected to lead higher earning potential going forward. Overseas Advances Composition Sep 2013 UAE Growth Prospects Bahrain, 11% 6 GDP Growth Average Qatar, 1 4 2 UAE, 6 Yemen, 11% Others, 0 2 4 6 2007 2008 2009 2010 2011 2012 2013F 2014F 2015F Source: World Bank and IMF Rising non core income to strength overall earnings The bank s non funded income underscored a robust growth of 35% YoY in 2012; contributing 33% to overall bank s operating income (3 rd highest in top tier banks). Unprecedented growth in non funded income is a function of higher fee, commission income generated on the back of higher trade related activities, escalating inward remittances and dominance in branchless banking. We believe, the bank will remain a favorable franchise for fee and commission based business because of its deep rooted presence in the segment coupled with bank s efforts to retain its ascendancy in branchless banking. Going forward, we have assumed non funded income to hover around 32 33% of total operating income 2013 18E. Non funded income to total income Composition of Non funded income 6 5 5 Fee, Commission, Brokerage Capital Gain Other Income 12 Dividend Income FX Income 4 3 2 21% 31% 2 3 33% 10 8 6 1 17% 27% 11% 5% 1 19% 1 1 23% 11% 1 1 HBL NBP ABL MCB BAFL UBL or sell the securities mentioned. 4 5 4 2 61% 5 63% 55% 48% 2008 2009 2010 2011 2012
UBL Omni; growing by leaps and bounds UBL is enjoying market leadership in branchless banking since its launch in Apr10 and currently servicing more than 1.3mn account holders through a network of 790+ outlets and 12,000+ agents. The bank is planning to increase its headcount agents to cross 13,000+ marks by the end 2013 for taping ~7 population which has no access to banking operations. Transactions pertaining to Omni reached to PKR355bn, showing an outstanding surge of 11 from 2012. Though, we foresee a great potential in branchless banking but it s worth mentioning that all major banks have already launched various products catering branchless banking hence UBL has to put special efforts for maintaining market dominance. Rising prospects of Omni Transaction Vol. (LHS) Headcount (RHS) PKRbn 500 450 400 350 300 250 200 150 100 50 0 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13F 14,000 13,000 12,000 11,000 10,000 9,000 8,000 UBL to safely comply with Basel III requirements According to SBP s circular regarding implementation of Basel III accord, every bank has to comply with capital structure provided in Basel III by Dec13. Currently, the bank s CAR is standing at 13.5% as at Sep13 (14.8% in Dec13); safely above 1 of risk weighted assets required by SBP. Furthermore, bank s Tier 1 CAR stood at 10.1%, down from 10.5% in Dec13. This decline in CAR is primarily on account of early repayment of its TFC IV after completing regulatory requirement. Moreover, SBP is likely to revise its MCR requirement which will bring further clarity on mandatory capital structure going forward. Below is the table indicating Basel III requirement announced by SBP. Basel III framework Ratio 2013 2014 2015 2016 2017 2018 2019 CET 1 5. 5.5% 6. 6. 6. 6. 6. ADT 1 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% 1.5% Tier 1 6.5% 7. 7.5% 7.5% 7.5% 7.5% 7.5% Total Capital 10. 10. 10. 10. 10. 10. 10. CCB 0. 0. 0.3% 0.7% 1.3% 1.9% 2.5% Total Capital 10. 10. 10.3% 10.7% 11.3% 11.9% 12.5% Source: SBP or sell the securities mentioned. 6 5
Valuation We prefer DDM and RIVM method for valuing Pakistan Banking space and average of these matrices derive our fair value for the scrip. Based on these methodologies, Dec14 TP is at PKR133/sh, offering an upside potential of. Further, looking at historic payout trend, we have assumed the bank to maintain payout ratio to ~58% annually. Thus, the scrip also offers dividend yield of 7%. Though at current levels, the scrip doesn t excite us in terms of total return however any major dip in the market price can originate a fair buy call. Cost of equity (PKRmn) Cost of Equity RFR 12. 10 year PIB Beta 1.04 Risk Premium 6. Cost of Equity 18.8% DDM CY14F CY15F CY16F CY17F CY18F Terminal Value Total Dividend 11,622 15,042 16,180 19,294 20,034 249,253 PV of Dividend 11,622 12,658 11,456 11,495 10,044 105,154 Sum of PV 162,430 DDM/Sh (PKR) 132 RIVM CY14F CY15F CY16F CY17F CY18F PAT 20,037 25,935 27,896 33,265 34,541 Return on Equity 21,430 27,609 29,644 35,248 36,568 Equity Charge 17,655 20,370 22,811 26,048 28,939 Residual Income (RI) 3,775 7,239 6,833 9,200 7,629 PV of RI 3,775 6,092 4,838 5,481 3,825 Sum of PV 24,011 Terminal Value 55,273 Current Equity 83,889 RIVM/Sh (PKR) 133 Average (PKR) 133 Source: BMA Research Key Assumptions The cost of equity is derived from capital asset pricing model where RFR is assumed at 12. (latest 10yr PIB auction) along with market risk premium of and 3yr adjusted beta of 1.04. We have assumed higher discount rate in 2014 2016 and 11.5% as a long term discount rate. The bank s prudent risk management policy will remain intact going forward which will not only contain accumulation in NPLs but also improve coverage ratio to 8 2014 18E. Banks deposit mobilization strategy will be evenly distributed in ADR and IDR however incremental deposits will be skewed towards advances. We do not see significant change in ADR primarily due to prevailing structural issues which are restricting credit demand. We believe, bank s average IDR will remain close to ~5 in 2014 2018E with major investment exposure coming in government securities. The profitability of offshore banking is likely to increase on the back of improve macro economic fundamentals in ME region particularly UAE, as discussed earlier. or sell the securities mentioned. 6 7
Key risk to our assumptions Macro Risk Political Risk: Political stability is one of the prime ingredients for economic prosperity and any unfortunate event that destabilizes political environment can have adverse impact on economy as well as banking sector. Regulatory changes: The banking sector in Pakistan is highly regulated by SBP and recent pegging of MDR with repo rate is one such incident that has dented bank s earnings despite expected increasing interest rate cycle. Weak economic growth: The newly enrolled program with IMF envisaged the goal of fiscal consolidation which will obviously curtail GDP growth in next two to three years. Any delays in fiscal reformation coupled with insistent energy crisis will limit economic activity and thus adversely affect the overall banking system. Low growth GDP will also augment NPLs accumulation, we believe. Risk Specific to UBL Vulnerability in offshore banking: Offshore banking operation is saturated to ME region particularly UAE and any slowdown will contain UBL s profitability. Higher operating costs on the back of higher inflationary expectation: Due to fiscal consolidation measures, inflations is likely to be on higher side in following 2 3 years which may push operating cost northwest. or sell the securities mentioned. 78