Hong Leong Finance - DBS Research 2017-11-13: Building Momentum

Hong Leong Finance - DBS Vickers 2017-11-13: Building Momentum HONG LEONG FINANCE LIMITED S41.SI

Hong Leong Finance - Building Momentum

  • Hong Leong Finance's 3Q17 earnings above expectations; at an inflection point with improved loan yields and loan growth.
  • Raising FY17-19F earnings on higher NIM and loan growth; potential uplift in dividends to c.5% yield.
  • Beneficiary of rising interest rates and macro environment, albeit smaller impact vs banks; sustained improvement in earnings traction should support share price momentum; M&A possibility is a bonus. 
  • Maintain BUY, TP of S$3.20.



Beneficiary of better macroeconomic environment; M&A potential.

  • Hong Leong Finance (HLF) has a unique role to play in the Small Medium Enterprises lending scene in Singapore as the largest financial company (finco) locally. We believe HLF will benefit from the better macroeconomic environment as we have started to see better loan growth and loan yields returning in 3Q17, in line with higher systemic loan growth and better interest rate outlook. 
  • The strong 9M17 earnings prompted us to raise FY17F earnings by 5% on higher NIM and loan growth. 
  • On a positive outlook on the macro front and interest rate environment, we also expect loan growth and NIM to improve, hence raising FY18-19F earnings by 5-13% p.a. 


Sustained improvement in earnings traction should be positive to share price.

  • Elsewhere, we believe that with the MAS’ rule relaxation on fincos in mid-Feb 2017, which lifted the limits on uncollateralised loans as a percentage of capital funds (from 10% to 25% of capital funds) and liberalised its existing policy to allow a foreign takeover of a finco (subject to certain conditions), opens new opportunities for HLF.


Where we differ. 

  • We are the only broker covering the stock. Post MAS’ rule relaxation, all three fincos have re-rated on possibility of M&A. However, we believe Hong Leong Finance’s current share price has yet to price in this year’s earnings recovery, as well as its strength as the largest finco in Singapore.


Potential catalyst. 

  • Sustained improvement in earnings profile should support share price momentum. 
  • Additional catalysts would include further relaxation of funding and lending rules, as well as M&A newsflow. Under a M&A scenario, which is a bonus for the company, we believe HLF should attract a minimum 1x BV or S$3.80 as current shareholders are unlikely to sell out at lower valuation given its prospects under the expected new regulatory regime.



WHAT’S NEW - Strong earnings growth continues; results above expectations 


Highlights 

  • Hong Leong Finance (HLF) continues its strong earnings growth momentum and recorded S$23.6m net profit in 3Q17 (+84.2% y-o-y/+12.9% q-o-q), despite recognising a one-off provision of S$2.8m, as broad-based growth in net interest income across interest on loans, hiring charges, and other interest income kicked in, from higher loan yields and loan growth of 2.2% during the quarter, as well as lower cost of funding partially offset by a lower average loan base. 
  • Fee income also grew 26.3% y-o-y/-6.5% q-o-q in 3Q17 to S$3.8m.

One-off provision of S$2.8m. 

  • In 3Q17, HLF topped up provisions by S$2.8m. Including reversal of provisions in 1H17, 9M17 provisions stood at S$2.5m. We remain confident on HLF’s asset quality as demonstrated by its low provision and NPL levels historically. 
  • What remains a wildcard is the effect of the implementation of IFRS9/SFRS109.


Outlook 


Loan growth of 2.2% q-o-q encouraging. 

  • We believe loan contraction bottomed out in 1Q17 as loan book saw first significant tick up in 3Q17 after remaining largely flat in 2Q17 after seeing a contraction through FY2016. 
  • We believe that loan growth is set for recovery against better economic conditions with encouraging signs of an improving property market and GDP outlook.

FY17-19F earnings raised by 5-13%; expect higher dividends.

  • We revised our earnings forecasts upwards by 5%/13%/9% in FY17F/18F/19F, reflecting better loan yields and loan growth outlook ahead. As a result, we now expect a minimum12 Scts dividend per share, a 33% increase from previous year’s dividend per share of 9 Scts. 
  • Stock is currently trading at ~4.4% dividend yield at current prices.  


Value and recommendation 

  • Maintain BUY, TP at S$3.20. Our TP of S$3.20 is derived from the Gordon Growth Model with 5% ROE, 2% long-term growth and 6% cost of equity, implying c.0.8x FY17F BV.
  • Despite a 5-9% earnings revision, we had previously already imputed prospects of it reaching an ROE level of 5%. The 3Q17 results has proven so.


Key Risks to Our View

  • As a smaller financial institution, and with exposure to riskier business lending, HLF may be more prone to asset-quality upsets should the economic cycle deteriorate. 
  • Also, HLF is more sensitive to changes in fixed deposits rate, in contrast to banks who have a large CASA base.






Singapore Research Team DBS Vickers | Sue Lin LIM DBS Vickers | http://www.dbsvickers.com/ 2017-11-13
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 3.200 Same 3.200



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