Malaysia Building Society Bhd
(Feb 23, RM2.24)
Downgrade to market perform rating with a lower target price (TP) of RM2.40: The proposed CIMB-RHBCap-MBSB merger and acquisition (M&A) has been officially scrapped. Consequently, MBSB’s share price has plummeted. In terms of fundamentals, the group’s full-year financial year ended Dec 31, 2014 (FY14) earnings were bolstered by a one-off recognition of RM366.1 million in deferred tax assets.

On exclusion, full-year earnings would have only narrowly met our expectations, coming in at 96% of our forecast. Premised on this and our expectations of slower loan growth and lower yield, we are downgrading MBSB to “market perform”. 

We were caught by surprise that the proposed merger of CIMB Islamic Bank, RHB Islamic Bank and MBSB was also called off, given that the proposed creation of the mega Islamic bank was independent of the CIMB-RHBCap merger and acquisition. However, we do not rule out that this could be due in part to the differences in MBSB’s provisioning standards, which arose in the course of the due diligence process. Nevertheless, we are encouraged by MBSB’s initiative in bringing forward its adoption of industry’s standards to FY14. 

Unlike for RHB Capital Bhd, and to some extent CIMB Bank Bhd, the proposed M&A was positive news for MBSB given that the value attached to MBSB shares was even higher than our then outperform target price of RM2.65 (forward price-to-book [PB] ratio: 1.5 times). Furthermore, the structure was such that MBSB shareholders could elect to receive cash or shares in the unlisted enlarged Islamic banking entity. 

Given the favourable scenario, we advised investors to accept the offer at RM2.82 (forward PB ratio: 1.6 times) should the merger go through. The market seemed to have agreed with the aforementioned view. MBSB’s share price rose from its initial price of RM2.37 (forward PB ratio: 1.3 times) on Oct 8, 2014 to an all-time high of RM2.66 (forward PB ratio: 1.5 times) (+12%) on Oct 13, 2014. 

The dismissal by Bursa Malaysia of the appeal to allow the Employees Provident Fund to vote, however, saw the group’s share price falling from RM2.51 (forward PB ratio: 1.4x) prior to the announcement on Dec 10, 2014 to RM2.16 as of yesterday (forward PB ratio: 1.2x) (-14%). FY14 earnings narrowly met our expectation at 96%. In terms of fundamentals, the group’s recent FY14 results were ahead of expectations, accounting for 150%/142% of our estimate/street numbers, owing to a one-off recognition of RM366.1 million in deferred tax assets (DTA). If this item is excluded, we estimate that core net profit would have narrowly met our expectation at 96%. 

Year-on-year (y-o-y), FY14 net profit advanced 69.9% to RM1 billion due in part to an outstanding 149.8% growth in net interest income (NII) to RM244.5 million. The other income segments did not fare as well with Islamic banking income (IBI) (-18.8%) and non-interest income (NOII) (-34.7%). both recording declines. The net result was a 9.3% fall in total income to RM1 billion.

The decline was reversed at the net profit level on lower-loan loss provision to RM126.2 million (-54.2%) and the recognition of DTA amounting to a large RM366.1 million. A higher cost-to-income (CI) ratio of 30.7% (+5.7 percentage points [ppts]), however, capped growth. If the DTA were to be excluded, the estimated core net profit would have been much lower at RM649 million, representing 8.6% advancement. The gross loan-to-deposit (LD) ratio was up 5.5 percentage points to 118.7% with gross loan growth gaining 2.4% while deposits slipped 2.3%. Asset quality deteriorated with gross impaired loan (GIL) ratio increasing to 6.6% (+1.4ppts). Nevertheless, the credit cost ratio was lower at 39 basis points (-47 basis points) on a lumpy RM15.6 million write-back in the second quarter of FY14 (2QFY14). Consequently, loan-loss coverage (LLC) ratio plunged to 67% (-31.2ppts).

Meanwhile, return on equity (ROE) came in 4.9 percentage points lower at 22.7%, given an enlarged share base. Quarter-on-quarter (q-o-q), 4QFY14 net profit doubled (+104.3%) to RM393.1 million partly on an increase in NOII (-42.2%) to RM26.8 million. On the downside, NII (-9.5%) and IBI (34.8%) both reported declines. 

As such, total income plunged to RM270.5 million (-26.6%). Nevertheless, the decline was more than offset at the net profit level given that the large DTA was recognised during the quarter (vs tax of RM114.8m in 4QFY13). Growth in net profit, however, was capped by a higher CI ratio of 30.7% (+5.7ppts), sticky operating expenses (+11%), and higher loan-loss provision (+ more than 100%). On exclusion of the DTA, the estimated core net profit could have been 86% lower to RM27 million. FY15 forecast was trimmed by 7%. 

Judging from the reported numbers, recent industry statistics as well as our expectations of a slower growth in economy, we have adjusted FY15 earnings downwards by 7%. — Kenanga Research, Feb 23

This article first appeared in The Edge Financial Daily, on February 24, 2015.