CIMB Group Holdings Bhd
(Nov 10, RM6.33)
Maintain “hold” with a lower target price (TP) of RM6.90 from RM7.50: The “strategic transfer” of headcount and branches from the CIMB Group Holdings (CIMB) and RHB Capital Bhd (RHBCap) merged entity to the newly-formed Islamic banking entity (combination of CIMB Islamic, RHB Islamic and Malaysia Building Society Bhd [MBSB]) would eliminate a huge chunk of integration costs, in our view.

This, we believe, is not priced in by the market. As the “new CIMB” would end up owning between 51% to 60% of the Islamic banking unit with a new strategic holder in the picture, 40% to 49% of the “costs” could effectively be eliminated.

The new strategic holder would share the initial “costs” (deemed integration costs) to build this mega Islamic bank.

On a proforma financial year 2015 (FY15) basis, we derived a RM7.20 book value of equity per share for the merged entity after taking into account new shares issued and share premium (RHBCap to CIMB shareholders), retained profits and other reserves, less cash paid to MBSB’s shareholders (ex-Employees Provident Fund), and less the reverse acquisition reserve (because of the specific accounting treatment).

With an estimated diluted return on equity at 10%, we derive a fair value for the merged entity of RM9.40, implying 1.3 times enlarged book value.

A clean set of financials (ex-integration distortions) should be seen by 2017.

Weaknesses facing CIMB stand-alone now include its Indonesian operations being weaker than expected and facing asset quality issues, and capital market activities, both in Malaysia and Indonesia, have been soft.

PT Bank CIMB Niaga Tbk’s results in the fourth quarter of FY14 will likely remain weak and could surprise on the downside. Provisions, loan growth and fee income prospects are key assumption changes. We trimmed our CIMB stand-alone earnings by 11% to 18% over FY14 to FY16.

Investors should be monitoring the 1.38 swap ratio between RHBCap and CIMB. There appears to be limited arbitrage opportunity, given that both stocks have been trading at close to the swap ratio. — Alliance DBS Research, Nov 10

This article first appeared in The Edge Financial Daily, on November 11, 2014.