CIMB Group Holdings Bhd
(May 18, RM5.95)
Maintain market perform with a target price (TP) of RM6.02: Last Friday, CIMB Group Holdings announced that it will be offering a mutual separation scheme to its Malaysian and Indonesian employees. This is in attempt to further bring down its operating cost structure as personnel expenses make up a huge chunk of its costs. (financial year 2014 or FY14: 56%). 

We were not entirely surprised by the move as CIMB aims to be a leaner entity. This comes after a slew of headcount cuts within its investment banking business across the region.

To recap, CIMB hopes to achieve return on equity (ROE) in excess of 15% (FY14: 9%), common equity Tier-1 ratio of more than 11% (FY14: 11%), and cost-to-income ratio  of less than 50% (FY14: 59%) by 2018.

With this exercise, we still reckon that target 2018 (T18) is not an easy task for CIMB to accomplish. Structural and cyclical headwinds clouding the overall banking industry are hindrances to its aspiration — tepid loan or deposits growth, net interest margin (NIM) compression and weak capital market activities.

Based on our calculations, CIMB’s net profit needs to accelerate by a staggering four-year compound annual growth rate (CAGR) (2014 to 2018) of 26% in order to see its ROE climb above 15%. In our opinion, this is a difficult feat to pull off.

PT CIMB Niaga Tbk, its 98%-owned Indonesia subsidiary,  will continue to drag the group’s overall financial performance (contributed 19% of FY14 profit before tax or PBT) as it is likely to grapple with another round of high bad loan provisioning in the second quarter of 2015 (2Q15); its gross non-performing loans ratio is expected to rise and come in between 4% and 4.5% this year (1Q15: 4%). 

Furthermore, CIMB Niaga’s FY15 NIM is expected to taper below 5% (1Q15: 5.2%) as a result of the shift in its loan portfolio mix to higher quality assets.

No changes were made to our forecasts. The group is poised to release its 1Q15 results tomorrow.

Our Gordon growth model derives a TP of RM6.02 as unchanged. This is based on 1.24 times FY15 price-to-book ratio (P/B); we utilised: cost of equity of 8.8%, FY15 ROE of 10.1%, and terminal growth of 3%.

The lower P/B multiple is to reflect slower growth and weaker ROE generation moving forward. 

Recall that CIMB was traded at average P/B of two times for the past two years when it generated ROE of more than 15%.

Risks to our call are a steeper margin squeeze, a lower-than-expected loan and deposits growth, worse-than-expected deterioration in asset quality, and a further slowdown in capital market activities and adverse currency fluctuations. — Kenanga Investment Bank Bhd, May 18

This article first appeared in The Edge Financial Daily, on May 19, 2015.