(Member of Arab Bank Group) Investment Management Group Research Division Results Update MSM Ticker Reuters code BKMB BMAO.OM Target Price (RO) 0.959 Share Price (RO) 0.711 Upside 34.8% Rating BUY Market cap (RO mn) 765.8 Current PE (x) 10.7 Current P/BV (x) 1.35 Dividend Yield (%) 2.81 FY-09e FY-10e FY-11e EPS 0.084 0.106 0.139 Implied PE 11.4x 9.0x 6.9x Implied P/BV 1.3x 1.2x 1.1x 2.8 ) 2.3 O (R 1.8 e ric 1.3 P 0.8 0.3 Bank Muscat Price Relative Chart Bank Muscat Source: Zawya; OABINVEST Relative to MSM Absolute Performance Bank Muscat MSM 6M -16.2% -14.9% 12M -65.9% -52.9% YTD -10.8% -3.5% Bank Muscat Bank Muscat bottom line at RO 14mn (excluding exceptional gain on sale of investment and impairment for associates), dipped by 22.4% q o q. Bank s recurring non interest income is in line with our estimates. But unexpectedly lower gross yield beats our net interest income expectation. Our overall FY09 earnings estimates have remained unchanged, but we have adjusted our target price to RO 0.959 from RO 0.994 to reflect the recent issuance of 8% subordinate bond. Based on our positive outlook on 7% convertible bond issuance we reiterate our BUY rating. Q1 09 Results Overview Declining gross yield eroding spreads Interest income came lower than our expectation on the back of diminishing LIBOR rate which resulted in lower yields on bank placements. Therefore, lower than expected gross yield and marginal increase in funding cost (20bps q o q) led to 81bps (q o q) reduction in spreads, resulting into a 15.5% q o q decline in net interest income at RO 39.6mn. Although increasing proportion of loans (51% in Q1 09 as compared to historical average of 44%) falling in higher interest rate band of 7% 9% should improve gross yields. But simultaneous rise in deposits (30% in Q1 09 compared to historical average of 15%) falling in high interest rate bracket of 4% 6% will overshadow higher gross yields impact. We continue to believe that funding cost will move northwards on account of issuance of CDs, 7% convertible bond and 8% subordinate bonds, but due to its better positioning Bank Muscat to certain extent can reduce its impact by re pricing its loan book. Taking into consideration all these factors, we conservatively forecast spread of 3.7% in FY09. 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% Operational Efficiency 2.0% FY 07 Q1 08 Q2 08 Q3 08 Q4 08 FY 08 Q1 09 FY 09e Gross Yield Funding cost Spread
Recurring non interest income as expected Non interest income (excluding one off gain on sale of 81% stake of HDFC) at RO 15mn plunged 13.8% q o q and was in line with our estimates of RO 15.9mn. Further, 86.6% q o q hike in provisioning and 57% q o q dip in recoveries led to 22.4% q o q decline in bottom line at RO 14mn (excluding exceptional gain on sale of investment and impairment for associates). Reported loan loss provisioning and share of loss from associates meet our forecast. But recoveries at RO 1.1mn were 67.6% higher than our estimate. Mounting NPLs deteriorating asset quality As expected, bank reported a slowdown in credit off take (26.6% y o y and 1.6% q o q) at RO 3.9bn. In line with our view, NPLs grew by 12% q o q to RO 101mn and formed 2.59% of gross loan in Q1 09 as against 2.35% in Q4 08. We maintain our view that economic slowdown leading to lower earning will increase the probability of higher number of defaulters. Thus we have kept NPL/Gross loan higher at 3.5% in FY09 and shown a downward trend in subsequent years. We believe to mitigate its risk Bank Muscat will consciously increase its provisioning. Slower growth in Gross loan (RO'000) 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% FY 07 Q1 08 Q2 08 Q3 08 Q4 08 FY 08 Q1 09 4,500,000 4,000,000 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 Gross loans and advances NPL/Gross Loan Bullish on bond issuance Although customer deposits plummeted slightly by 1.4% q o q in Q1 09, thereby increasing loanto deposit ratio to 125% compared to 121.4% in Q4 08. But bank s move to raise CD s worth RO 250mn, issuance of 7% convertible bond (of RO 32.3mn) and 8% subordinate bond (of RO 60mn) will enable Bank Muscat to better maintain its lending ratio and replace its Floating rate notes (which will mature on 26 May 09). In our view, 7% convertible bond issuance is a win win situation for Bank Muscat and investor community. Apart from retaining higher profits, bonds issuance will also strengthen the capital adequacy ratio of bank which stands at 13.05% in Q1 09. Moreover, tax deductible interest expense (on these bonds) is an added advantage to the bank. We calculated Yield to maturity (YTM), to evaluate the benefit of 7% convertible bond from investor s perspective. Our approach is based on the following assumptions: Investment outlay is based on current market price of 7% convertible bond Investor will sell off shares received after conversion of bonds at maturity As a close proxy we are assuming 3M average share price (prior to conversion date) equal to the market price at the time of maturity 2
RO'000 2009 2010 2011 2012 2013 2014 No. of 7% Convertible Bonds ('000) 32,314 Coupon rate 7.0% Bond Value 32,314 Maturity 50% redemption on 3rd year and remaining on 5th year Interest payment Semi annually (on 15 Apr & 15 Oct) Bond Value 32,314 32,314 32,314 16,157 16,157 Interest 1,131 2,262 2,262 1,696 1,131 565 Profit on sale of converted shares 4,039 4,039 Total cash flow 1,131 2,262 2,262 21,893 1,131 20,762 Total Investment (29,794) YTM 11.75% Higher YTM at 11.75% as against our assumption of 8% cost of equity makes us bullish on 7% convertible bond issuance. Our calculation also reveals that since bond's coupon rate (at 7%) is less than its YTM the bond is selling at a discount and investors should capitalize the opportunity with a long term perspective. Outlook Our overall assumptions have not been revised but after incorporating the impact of recent issuance of 8% subordinate bonds our target price declined to RO 0.959 from RO 0.994. We continue to believe that overall economic downturn will restrict the credit as well as deposit growth. We maintain our view that higher funding cost and flattish gross yield will put FY09 spreads under pressure. We remain cautious of deterioration in the loan book in the medium term, thus we provide for higher loan loss provisioning. In our view, as Bank Muscat s AFS investments are 17.7% of net worth in Q1 09, which is highest as compared to its listed peers, thus it is more prone to AFS adjustment. We are optimistic on 7% convertible bond issuance and consider it to be a good investment opportunity. Valuation We have used Residual Income Approach, where target price is ascertained based on intrinsic value of bank. We have calculated residual income for actual forecasted years (FY08 FY12) based on detailed financial forecasts. For the next 10 years (FY13 FY22), we have assumed net profit to grow at a CAGR of 6% and in declining stage (FY23 FY32) our basic assumption for calculating residual income is that as ROE tend towards COE, it will become equal to the cost of equity. Thus we have achieved at a fair value of RO 0.847 and target price of RO 0.959. Thus at current price our valuation suggests a total potential return of 34.8% and we retain BUY rating on the back of positive outlook on bond issuance. Moreover, we also believe prevailing lower prices provides a good entry point. 3
Valuation Summary RO '000 FY-08 FY-09e FY-10e FY-11e FY-12e Net Profit 93,731 90,860 114,407 149,822 178,135 Dividend 53,850 40,887 51,483 67,420 80,161 Net worth 714,750 780,610 848,207 941,156 1,030,809 ROE 14.9% 12.7% 14.7% 17.7% 18.9% Residual Income 10,978-3,389 11,474 37,976 54,032 Total PV of Residual Income (FY2009-32) 197,643 Intrinsic value 912,393 Total issued shares (in '000) 1,077,134 Value per share (RO) - fair value 0.847 Target share price (RO) 0.959 Current market price (RO) 0.711 Upside/downside 34.8% Risk Better than expected credit growth; higher recoveries from defaulters and recovery of financial markets poses an upside risk to our valuation. Any further losses from investments in Saudi Pak Bank will negatively impact our profit estimates. Bank Muscat Key Indicators Q1-08 Q2-08 Q3-08 Q4-08 FY-08 Q1-09 FY-09e FY-10e FY-11e OPERATIONAL EFFICIENCY Gross Yield 6.8% 6.1% 6.1% 6.3% 6.3% 5.7% 6.4% 6.4% 6.3% Funding cost 2.8% 2.4% 2.4% 2.3% 2.5% 2.6% 2.7% 2.7% 2.6% Spread 4.0% 3.7% 3.7% 4.0% 3.9% 3.2% 3.7% 3.7% 3.7% Net interest margin 4.1% 3.8% 3.8% 4.0% 3.9% 3.2% 3.6% 3.6% 3.7% Operating Profit margin 55.3% 64.9% 54.4% 57.4% 57.9% 96.4% 48.1% 47.9% 48.4% Interest income/operating income 67.3% 60.3% 71.4% 74.8% 68.5% 44.5% 74.7% 75.1% 75.7% Non-interest income/operating income 32.7% 39.7% 28.6% 25.2% 31.5% 55.5% 25.3% 24.9% 24.3% Cost/Income ratio 38.1% 36.2% 36.8% 31.6% 35.6% 23.9% 36.6% 37.0% 37.6% PROFITABILITY ROE (%) 17.3% 19.0% 17.8% 2.0% 14.0% 27.7% 12.5% 14.0% 16.7% ROA (%) 2.4% 2.6% 2.4% 0.2% 1.8% 3.3% 1.5% 1.6% 1.9% VALUATION MEASURES P/E 20.2x 15.5x 9.5x 59.3x 9.2x 3.3x 8.4x 6.7x 5.1x P/BV 3.6x 2.7x 1.7x 1.2x 1.2x 0.9x 1.0x 0.9x 0.8x ASSET QUALITY NPL/Gross loan 2.7% 2.2% 2.0% 2.3% 2.3% 2.6% 3.5% 3.4% 3.2% Provision coverage ratio 138.5% 166.4% 168.8% 138.8% 138.8% 136.3% 121.9% 127.8% 127.0% LIQUIDITY AND SOLVENCY RATIO Loan deposit ratio 116.4% 118.2% 128.1% 121.4% 121.4% 125.2% 120.4% 119.3% 119.3% Lending ratio 91.8% 86.4% 85.1% 87.0% 87.0% 91.8% 83.2% 84.0% 84.7% Leverage 7.7x 7.0x 7.5x 8.4x 8.4x 8.4x 8.7x 8.9x 9.0x Gross loans as % total assets 67.1% 66.1% 64.8% 63.9% 63.9% 68.4% 63.0% 63.8% 65.0% Deposits as % total liabilities 66.3% 65.2% 58.4% 59.7% 59.7% 62.0% 59.1% 60.2% 61.2% 4
Income Statement Summary: in RO'000 Q1-08 Q2-08 Q3-08 Q4-08 FY - 08 Q1-09 FY-09e FY-10e FY-11e Interest Income 61,509 61,324 65,944 74,686 263,463 70,286 333,439 370,446 413,818 Interest Expense -24,467-23,693-25,397-27,799-101,356-30,668-144,615-159,039-170,639 Net Interest income 37,042 37,631 40,547 46,887 162,107 39,618 188,824 211,407 243,179 yoy growth 31.4% 20.9% 30.1% 36.5% 29.9% 7.0% 16.5% 12.0% 15.0% Other operating income 17,974 24,741 16,206 15,773 74,694 49,399 63,875 69,998 77,862 yoy growth 84.7% 124.1% 17.8% 16.2% 55.3% 174.8% -14.5% 9.6% 11.2% Foreign exchange 1,410 1,609 1,905 2,022 6,946 2,215 7,502 8,252 9,242 Commission and fees (net) 12,699 14,937 13,901 13,290 54,827 11,875 50,989 55,068 60,575 Dividend income 757 1,750 17 63 2,587 667 2,458 2,605 2,787 Profit on sale of non trading investments 2,588 5,772-64 -749 7,547 34,360-1,000 2,000 Other income 520 673 447 1,147 2,787 282 2,926 3,073 3,257 Unrealised gain on AFS investments - - - - - - - - - Operating Income 55,016 62,372 56,753 62,660 236,801 89,017 252,698 281,405 321,040 yoy growth 45.1% 48.0% 26.3% 30.7% 36.9% 61.8% 6.7% 11.4% 14.1% Operating Expenses -20,982-22,548-20,867-19,827-84,224-21,255-92,464-104,032-120,850 yoy growth 41.2% 34.1% 18.6% -5.9% 19.8% 1.3% 9.8% 12.5% 16.2% Other operating expenses -19,716-21,214-19,357-18,200-78,487-19,814-86,009-96,863-112,993 Depreciation -1,266-1,334-1,510-1,627-5,737-1,441-6,454-7,168-7,857 Operating Profit 34,034 39,824 35,886 42,833 152,577 67,762 160,235 177,373 200,190 yoy growth 47.6% 57.1% 31.3% 59.4% 48.7% 99.1% 5.0% 10.7% 12.9% Impairment for associates - - - -13,750-13,750 - - - - Recoveries(provision) for collateral assets - - - 13 13 - - - - Impairment for investments - - - -10,929-10,929-1,720-11,257-7,039-4,974 Impairment (provision) for credit losses -6,539-6,542-5,549-5,995-24,625-11,187-47,048-45,915-33,059 Recoveries from impairment for credit losses 1,688 2,122 6,160 2,633 12,603 1,137 2,714 4,491 6,984 Share of profit(loss) from associates 2,107 700-315 -5,740-3,248-325 -1,394 1,098 1,111 Recoveries from provision for placements - 583 - - 583 - - - - Impairment for placements - - - -4,813-4,813 - - - - Profit Before Taxation 31,290 36,687 36,182 4,252 108,411 55,667 103,249 130,008 170,253 Tax expense -4,750-5,400-3,900-630 -14,680-7,250-12,390-15,601-20,430 Net profit for the year 26,540 31,287 32,282 3,622 93,731 48,417 90,860 114,407 149,822 yoy growth 39.2% 47.9% 44.1% -83.3% 11.2% 82.4% -3.1% 25.9% 31.0% Balance Sheet Summary: in RO'000 7 Q1-08 Q2-08 Q3-08 Q4-08 FY-08 Q1-09 FY-09e FY-10e FY-11e Cash 321,972 335,308 430,755 452,761 452,761 451,212 594,778 567,312 544,493 Placements with banks 779,782 810,266 910,853 1,077,557 1,077,557 984,838 1,211,990 1,345,309 1,448,794 Gross loans and advances 3,094,257 3,312,877 3,607,553 3,853,274 3,853,274 3,915,852 4,277,134 4,833,162 5,509,804 yoy growth 45.0% 44.1% 46.3% 37.8% 37.8% 26.6% 11.0% 13.0% 14.0% (-) Impairment -115,614-121,105-122,162-125,574-125,574-138,085-182,486-210,040-223,966 Net loans and advances 2,978,643 3,191,772 3,485,391 3,727,700 3,727,700 3,777,767 4,094,649 4,623,121 5,285,838 yoy growth 46.4% 45.1% 47.6% 38.7% 38.7% 26.8% 9.8% 12.9% 14.3% Investments 144,602 407,670 458,363 378,646 378,646 209,599 433,664 507,899 603,958 Investment in associates 137,866 119,087 112,924 92,903 92,903 91,771 91,509 92,608 93,719 Net Property and equipment 20,677 21,242 21,910 21,948 21,948 21,884 24,434 26,461 27,828 Other assets 226,175 127,647 143,158 276,721 276,721 189,232 341,666 409,931 477,528 Assets 4,609,717 5,012,992 5,563,354 6,028,236 6,028,236 5,726,303 6,792,690 7,572,641 8,482,159 Deposits from banks 751,623 973,241 1,417,034 1,412,576 1,412,576 1,188,503 1,553,834 1,724,755 1,931,726 Customers' deposits 2,657,720 2,802,994 2,816,829 3,173,032 3,173,032 3,127,616 3,553,796 4,051,327 4,618,513 yoy growth 30.3% 30.2% 23.7% 36.6% 36.6% 17.7% 12.0% 14.0% 14.0% Certificates of deposit 13,285 13,225 31,675 61,675 61,675 97,750 247,500 222,750 200,475 Floating rate notes 111,650 111,650 111,650 111,650 111,650 111,650 - - - Unsecured bonds 54,803 54,803 54,803 54,803 54,803 54,803 54,803 54,803 54,803 Other liabilities 295,886 211,522 253,669 360,138 360,138 314,793 428,648 497,298 561,986 Taxation 14,434 19,084 22,984 26,112 26,112 33,281 - - - Subordinated liability 108,500 113,500 113,500 113,500 113,500 113,500 113,500 113,500 113,500 Subordinate bonds - - - - - - 60,000 60,000 60,000 Laibilities 4,007,901 4,300,019 4,822,144 5,313,486 5,313,486 5,041,896 6,012,080 6,724,434 7,541,003 Share capital 107,713 107,713 107,713 107,713 107,713 107,713 107,713 107,713 107,713 Share premium 301,505 301,505 301,505 301,505 301,505 301,505 301,505 301,505 301,505 Convertible bonds - - - - - 32,314 32,314 32,314 32,314 General reserve 56,308 56,308 56,308 56,308 56,308 56,308 56,308 56,308 56,308 Legal reserve 35,905 35,905 35,905 35,905 35,905 35,905 35,905 35,905 35,905 Revaluation reserve 3,957 3,957 3,957 3,957 3,957 3,957 3,957 3,957 3,957 Subordinated loan reserve 2,567 2,567 2,567 24,200 24,200 24,200 24,200 24,200 24,200 Cumulative changes in fair value 12,397 96,992 98,821 69,276 69,276 13,171 65,812 59,889 54,499 Retained profit 81,464 108,026 134,434 115,886 115,886 109,334 152,896 226,416 324,755 Shareholders' Funds 601,816 712,973 741,210 714,750 714,750 684,407 780,610 848,207 941,156 Total Liab. & shareholders' funds 4,609,717 5,012,992 5,563,354 6,028,236 6,028,236 5,726,303 6,792,690 7,572,641 8,482,159 5
Research research@oabinvest.com +968 24762342 Oman Arab Bank Investment Management Group (IMG) Gunjan Gupta Senior Research Analyst Ahmed Al Lawati Investment Analyst Assistant This report has been prepared and issued by the IMG Oman Arab Bank SAOC on the basis of publicly available information, internal data, and other sources considered reliable. While the utmost care has been taken to ensure that the facts stated are accurate and the opinions given are reasonable, neither Oman Arab Bank SAOC nor any of its employees shall be in any way responsible for the contents. This report is not to be considered as an offer to buy or sell the securities referred to in the report. 6