Lead Story: Marked improvement in earnings expected this year

This article first appeared in Capital, The Edge Malaysia Weekly, on June 26, 2017 - July 02, 2017.
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THE banking sector looks like it has finally got out of the rut it found itself in two years ago, judging by the share price performance this year. The heavyweights of the sector — such as CIMB Group Holdings Bhd and Malayan Banking Bhd — have been leading the pack in the rally seen on the FBM KLCI, and some market watchers predict the benchmark index will breach 1,800 points soon.

Last Wednesday, it closed at 1,775.57 points, an increase of 8.15% from Jan 3. Of the top 10 gainers since then, four are banks.

CIMB tops the chart, gaining 54% to RM6.65 since the start of the year. Maybank follows closely behind, with a 25.16% increase in its share price over the same period. The other two banks in the top 10 are AMMB Holdings Bhd and Hong Leong Bank Bhd, which have gained 18.33% and 16.48% respectively.

The substantial rise begs the question as to how much further the stocks can increase.

“Any further climb in share prices, of course, hinges on the counters’ ability to deliver earnings growth. In the recent 1Q2017 results, we did see some relief as the sector kicked off the year on a positive note with some healthy figures. The sector posted 7% year-on-year growth in core operating profit — largely from stable net interest margins (NIMs) and more cost-cutting measures,” says Affin Hwang Asset Management head of equity strategies and advisory Gan Eng Peng.

Areca Capital CEO Danny Wong, meanwhile, is looking forward to the 2QFY2017 earnings, which will be out in July and August. He says there should be more room for growth in share prices if earnings can catch up with valuations, adding that some banking stocks have already risen substantially in recent times and are now fairly valued.

Banks have always been seen as a proxy for economic growth. Malaysia’s gross domestic product (GDP) grew 5.6% y-o-y in the first quarter, which was followed by announcements of stronger 1Q2017 earnings by banks. This could have lend some confidence to the sector.

Gan says he is seeing improving economic fundamentals and growth, which could lead to a pickup in lending activities. If this current economic upturn stays, the banking sector would continue to deliver on earnings, he adds.

“Thus, laggard banks such as Public Bank [Bhd] and Hong Leong Bank could eventually play catch up with the likes of CIMB and Maybank,” he remarks.

Banking analysts expect to see a marked improvement in earnings this year compared with the previous year. CIMB Investment Bank Research’s Winson Ng is forecasting a net profit growth of 9.2% for the banks under his coverage, compared with the meagre 0.9% increase seen last year.

“The catalyst would be the expected normalisation in loan loss provisioning, with a projected increase of only 6% in 2017 versus a jump of 67.2% in 2016. We also envisage an improvement in banks’ top-line growth — from 4.5% in 2016 to 5.8% in 2017 for net interest income, and from 1.4% to 4.8% for non-interest income,” Ng writes in his latest research report.

Meanwhile, DBS Vickers Securities analyst Lim Sue Lin opines that the positive NIM trend seen in the 1Q2017 would be sustainable as long as deposit competition stays rational.

“Industry loan growth was 6% y-o-y in 1Q2017 while the April 2017 industry loan approval rate was steady at 42%. The capital markets’ momentum should also add to stronger fee income in the quarters ahead,” Lim says in her research report.

The banking sector’s average price-to-book (PB) ratio stands at 1.47 times, with the highest being Public Bank’s at 2.3 times and the lowest, AMMB’s, at 0.96 times. Meanwhile, the average price-earnings ratio is at 13.36 times, with Public Bank the most pricey at 15.06 times and AMMB the cheapest at 11.55 times.

Although the valuations are lower than what they were previously, they are still higher than those in neighbouring countries such as Singapore and Thailand, where the average PB ratio is at 1.24 times and 1.06 times respectively.

Indonesian banks, though, have a higher PB ratio, at 1.95 times.

However, Wong is of the view that it is difficult to compare valuations with regional banks as it is not an “apple to apple” comparison, given the vastly different economic landscape and investor profile.

“There are many large local institutions holding stakes in Malaysian banks. This has pushed the valuations to a slightly higher premium compared with [those of] other banks in the region. It has always been the case,” he says.

The last two years have proved to be challenging for the local banking sector. As economic growth slowed and global crude oil prices faltered, many banks were faced with lower net interest income, higher cost, an uptick in non-performing loans and large amounts of impairments that needed to be undertaken to limit the increase in impaired loans.

But with economic conditions looking better these days, Wong believes the worst is behind the banks now. He says they have a low base this year and their earnings will continue to improve.

“Any further share price gains will depend on whether they can catch up with valuations,” Wong says, adding that investors should look at the laggards in the sector.