Sing Investments & Finance Limited - Phillip Securities 2017-07-24: Massive 40% PATMI Growth In FY17e

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SING INVESTMENTS & FINANCE LTD S35.SI

Sing Investments & Finance Limited - Massive 40% PATMI Growth In FY17e

• Expect sharp increase in PATMI as NIM improves on rising rates and provisioning normalises.
• Regulatory changes a multi-year driver to expand margins and volume.
• Potential to tap on E-commerce sales channel to originate loans in the low and middle markets.
• Initiate coverage on Sing Investments & Finance Limited with “Accumulate” rating with a target price of S$1.67, implying an upside of 18.58% (including FY17e dividends).

Investment Highlights 

1. We expect FY17e to be a strong year for SIF, as it benefits from the twin tailwinds of rising interest rates and regulatory changes to the finance business. SIF is expected to grow PATMI by 40% in FY17e because of pass through of higher customer loan rates, the roll-out of lower cost current account services and normalisation of bad loans provisioning as NPL stabilises.
2. Regulatory changes announced on 14 Feb 2017 will be a multi-year driver to earnings. After years of constraint, the authorities have finally unshackled the finance companies. We expect volume upside as SIF enters the uncollateralised loans business and penetrate deeper into SME business. We also expect margins to improve as SIF can now source lower cost current account deposits from its existing client base.
3. Visible and rapid developments in SEA E-commerce scene and regulatory changes to uncollateralised business loans present clear opportunities to originate loans in the low and middle markets. We expect E-commerce players to aggressively develop credit financing capabilities in SEA after having invested heavily in logistics and epayments. However, we believe E-commerce players will seek partnerships with credit finance companies to take on and manage the credit risks. Credit finance companies can also leverage on E-commerce data analytics to better assess credit risks of sellers in the low and middle market segment. Together with the regulatory changes to uncollateralised business loans, credit finance companies can then confidently extend loans to the low and middle market customers.
4. Compared to its peers, SIF ranks best in cost to income and other efficiency metrics. The de-regulation opportunity and SIF higher efficiency, justifies higher P/BV valuation, in our opinion. We believe SIF’s price-to-book valuation is conservative considering its ROE performance. In addition to the industry tailwinds, we expect SIF’s operating efficiency and pricing flexibility to further support the improvement in SIF’s ROE of 4.33% in FY16 to 5.7% in FY17e.

Investment Actions 

• We initiate coverage on Sing Investments & Finance Limited with an “Accumulate” rating and a target price of S$1.67. 
• Our valuation is based on 0.8x P/BV. This implies an upside of 18.58% (including FY17e dividends) from its last traded price of S$1.48.

Company Overview 

• Sing Investments & Finance Limited (“SIF”) is a finance company listed on the Singapore Stock Exchange with more than 50 years of lending experience.
• SIF’s activities cover the acceptance of Fixed and Saving deposits from the public and the provision of loans and credit facilities to individuals and corporations. SIF actively participates in events organized by SPRING Singapore and SCCCI to promote local entrepreneurs.
• SIF’s Loan Products and Credit Facilities include: 
  1. Residential and Commercial Property Loans 
  2. Land and Construction Loans 
  3. Machinery Loans under the Local Enterprise Finance Scheme 
  4. Motor Vehicle Loans (End user consumer auto loans) 
  5. Block Discounting Facility (Secured by receivables of Auto dealers) 
  6. Floor Stock Facility (Revolving credit inventory financing for Auto dealers) 
  7. Share Financing (Singapore listed equities) 
  8. Shipping Loan 
  9. Invoice Factoring/ Account Receivables. 
• SIF’s income is derived from: 
  1. Net interest income from loans and deposits 
  2. Interest income from Singapore Government Securities and Cash 
  3. Fees and commissions from loans and deposits business 
  4. Dividends from quoted equity securities 
  5. Rental income from investment properties 

Investment Thesis 

1. Singapore’s credit finance companies have greater potential to improve their Net Interest Margins (“NIMs”) because of regulatory changes and rising interest rates.

• The credit finance companies’ customer loan rates have been more volatile than the banks. We believe the volatility is due to their clientele being predominantly in the low and middle market client segment, therefore, more sensitive to the general economy and interest rate environment. The upward volatility of loan rates can be attributed to better pass through of interest rates as the low and middle market ($5mn to $100mn revenue companies) segment tends to be sticky and more accepting of higher rates. As interest rates are on a rising trend, we believe the credit finance companies are in a position to outperform.
• Conversely, credit finance companies’ cost of deposits is as sensitive to rising interest rates. However, with the regulatory changes allowing credit finance companies to offer current account and chequing services, they can now capture cheaper but short term deposits which can alleviate some upward pressure on deposit costs. In summary, we expect the credit finance companies’ loan rates to rise faster than their cost of deposits, resulting in expansion of NIMs in the near term.

2. We believe banks will not compete intensely with credit finance companies for low and middle market loans in the near term.

1. We expect the banks to prioritise high quality collateralised loans over the higher risk low and middle market loans. The low and middle loans market are inherently higher risk as we observe that Non-performing loans ratio (“NPLs) for the credit finance companies are higher than banks in general. Presently, the banks are still dealing with credit risks from the offshore oil and gas loans exposure and are mindful of their risk weighted assets to comply with Basel standards.
2. Clients to Relationship Managers ratio (“CRM ratio”) for Credit Finance Companies is lower than banks. The lower CRM ratio at the credit finance companies allows them to prioritise the low and middle market clientele and to forge a closer relationship. We do not expect the banks’ CRM ratio to catch up anytime soon as their compliance, risk management and corporate governance structuring costs are driven higher to comply with prudential measures; and cost saving initiatives are directed elsewhere including cutting sales workforce expense. While credit finance companies still have the advantage to allocate more resources to drive sales, future requirements to increase corporate governance and risk management costs could reduce the edge.
3. “Private banking” experience for SMEs. Just as the banks are driving a seamless customer experience in the upmarket private banking platform, we observe that the credit finance companies have a similar strategy for their low and middle market clients where the client’s personal and business needs are seamlessly taken care of. Again, owing to the operational complexities, the banks are unlikely to apply the same strategies on the long tail low and middle market (especially the low market segment) which lack the economies of scale for a larger scale banking business. 

• We expect the lower middle market clients to remain underserved in the near term thus creating a gap for the credit finance companies to fill and further strengthen their relationship with that segment.

3. Partnering E-commerce operators to finance their supply chain is an untapped potential 

• In the Amazon’s FY2016 report, Amazon Lending program is reported to be part of the leading strategy for E-commerce. The program is designed to provide funding to sellers to procure inventory. The size of the loans in this programme grew from US$337mil in 2015 to US$661mil in 2016. Amazon also intends to expand the Amazon Lending program and are working to partner with banks to leverage on the banks’ expertise to take and manage the bulk of the credit risk. In the same breath, Amazon had reiterated its broader ambition to help their sellers globalise their business. In 2016, Amazon had empowered entrepreneurs in 172 countries to reach customers in 189 countries, therefore, cross-border sales are almost a quarter of all 3rd party units sold on Amazon.
• The two key takeaways from the Amazon Lending program strategy are: 
  1. partnering with banks for their expertise to manage credit risks. 
  2. Global cross border network. 
• First, as from our 2nd point of the Investment Thesis, we believe credit finance companies are better partners for E-commerce player like Amazon because E-commerce and credit finance firms have a common major clientele they desire to serve – the low and middle market. 
• Second, the desire to establish a global cross border network means that E-commerce players will need overseas partners in credit finance just as they have for logistics and e-payments. So the 4th point of our Investment Thesis will describe the high growth potential of South East Asia’s Ecommerce and how credit finance companies from South East Asia can benefit.
• The game changer for credit finance companies is the opportunity to leverage on the data analytics from the E-commerce platforms to acquire a comprehensive understanding of the universe of individual E-commerce sellers. We see that a partnership can increase the finance companies’ penetration into the low and middle market. Such partnerships will offer opportunities to scale up the loans growth while providing better certainty and control over loans quality.

4. The loans origination growth potential in South East Asian’s (SEA) E-commerce space is enormous.

• In a report jointly issued by Google and Temasek, titled “Unlocking the $200billion digital opportunity in Southeast Asia”, the total first-hand E-commerce market* in SEA** is expected to grow at a 10-year CAGR of 32% to US$88bn by 2025 (US$5.5bn in 2015) outpacing offline retail’s 10-year CAGR of 7% and it is also expected to be the fastest growing compared to online media and travel. Therefore we see tremendous potential in SEA for credit finance companies to leverage on the online channel to originate more loans to sellers for inventory (apparel, electronics, household goods and food/grocery) procurement.

*Dollar spend on apparel, electronics, household goods, food/groceries.
**defined as Philippines, Thailand, Vietnam, Indonesia, Malaysia, and Singapore.

5. Singapore’s finance companies are in a propitious position to benefit from the Ecommerce ecosystem not only because of government initiatives but also as part of the next stage of E-commerce development in SEA.

• Owing to government initiatives to attract E-commerce platforms to help SMEs internationalise online and ease of doing business, big E-commerce names have invested heavily in Singapore: 
  1. Alibaba’s efforts to boost its presence in SEA via its acquisition of Singapore based Lazada and partnership with SingPost.
  2. Amazon setting up Ecommerce capabilities in Singapore.
  However, it is also clear that E-commerce players have so far been focused on boosting logistics capabilities and e-payment capabilities to be ahead of the game. 
• We expect the next area of focus for E-commerce platforms in Singapore would be the provision of financing to sellers to enhance their value proposition to SMEs and further differentiate themselves ahead of competitors. The liberalisation of shareholding policy for finance companies is an explicit opportunity for E-commerce players to further that value proposition by forming a potential partnership with Singaporean finance companies.

Investment Merits 

1. The regulatory changes could catalyse a meaningful increase in SIF’s net profit.

• Based on SIF’s FY2016 Share Capital and Equity Reserves of S$320mn, SIF’s uncollateralised business loan exposure to a single borrower could go as high as S$1.6mn. The limit on aggregate uncollateralised business loans will also be raised from 10% to 25% of its capital funds thus potentially raising its aggregate uncollateralised business loans limit from S$32mn to S$80mn. 
• We estimate the potential net interest income contribution to SIF from uncollateralised business lending is c.S$1.8mn thus adding 4.7% to SIF’s FY16 NII of S$38.6mn. Our estimations are based on the assumptions of a spread of c.3% per annum on an aggregate uncollateralised business loan size of c.S$60mn.
• Also, we believe there will be positive knock-on effects from increased activity in uncollateralised business lending. Finance companies can start building relationships with fledgeling SMEs through uncollaterised lending, and when these SMEs expand, there will be better opportunities to extend collateralised business loans by way of a stronger relationship.

2. Higher NIM and normalising of bad loans provisioning expense this year will also boost ROE and PATMI significantly.

• Based on SIF’s 1Q17 results, we estimate SIF’s NIM to be 1.67%, a 17bps increase from FY16 NIM of 1.50%. We expect FY17e NIM to be at c.1.7% because of higher yields from customer loans and lower upward pressure on deposit costs.
• In 2016, SIF was able to pass higher rates to customers while keeping NPL formation stable.. Barring economic volatility in FY17e, we expect NPL formation to remain stable. 
• Moreover, with ample bad loans coverage, we expect FY17e bad loans provisioning expense to normalise. As a result, SIF’s ROE could improve from 4.33% in FY16 to 5.7% in FY17e and PATMI could grow c.40% y-o-y.

3. High double digit percent net profit growth in FY17e could lead to an increase in dividends.

• With the higher in net profit in FY17e, we believe SIF could potentially increase its dividend per share (“DPS”) from 5 cents per share to 7.9 cents per share if the pay-out ratio of c.63% is maintained in FY17e and FY18e. 
• SIF will still be able to maintain their Capital Adequacy Ratio (“CAR”) above the 12% required by the Finance Companies Act. At SIF's current share price, we could see a potential dividend yield increase from c.4% to c.5%.

4. Strong financials.

1. Clean Balance Sheet. SIF does not have any debt save for S$2mn to S$3mn of SPRING loans. Other liabilities include accrued interest payables and operating expenses, factoring current accounts and other deposits. Other assets include accrued interest receivables and prepayments. Singapore Government Securities (“SGS”) make up c.99% of available-for-sale investments.
2. Customer loans are funded by adequate deposits, and SIF has good headroom to expand LDR to boost net interest income. SIF’s loans are adequately funded by deposits. As of end FY16, its loans to deposit (“LDR”) is at c.82% which is lower than the 3 Singapore banks’ average LDR and the 3 Singapore finance companies’ average LDR. 
3. We believe that SIF has more headroom than peers to expand the LDR to boost net interest income growth if a pass through of higher rates would cause loans growth to fall. This means that SIF can afford to expand LDR by reducing high-cost deposits faster than loans decline to grow net interest income.

5. SIF has the best operating efficiency and maintains pricing flexibility on loans and deposits.

• SIF has probably the most efficient deposit management amongst its peers. SIF enjoys the highest deposit per branch ratio amongst the three credit finance companies. We believe SIF’s superior deposit management efficiency is due to its strong broker distribution network and direct client relationship management. 
• SIF has also been improving its overall operating efficiency since 2013. Most of SIF’s customer loans and deposit interest rates are floating thus giving SIF more pricing flexibility. SIF’s interest rates use SIBOR and Internal Board Rates as a benchmark. 

Investment Risks 

1. Credit Risk 

• Credit Risk is the risk of financial loss to SIF if a borrower or counter party to a credit exposure fails to meet its contractual obligations. Credit exposures also include the debt securities held whose valuations will be negatively impacted by volatility in the global financial markets. Credit risk could increase if deterioration in loans quality outweighs the benefits of higher customer loan rates in a rising interest rates environment.

2. Liquidity Risk 

• Liquidity Risk is the risk that SIF is unable to service its cash obligations in the present and future (both anticipated and unanticipated) without incurring substantial cost or damage to its reputation. SIF’s principal source of funds is from deposit collections in Singapore which is mainly utilised for funding loans and maintenance of reserves in compliance with statutory requirements. SIF’s liquidity risk is also mitigated by a large number of customers in the Company’s diverse loans and deposits bases which is reflected in its relatively lower LDR.

3. Interest Rate Risk. 

• SIF may be exposed to a loss in earnings due to effects of fixed and floating interest rates of its assets and liabilities. As such, the interest rate spread between these two activities is monitored closely on an on-going basis to optimise its yields and manage its risk within the risk tolerance levels set by the Risk Management Committee (“RMC”) and the Board. 
• The Interest Rate Working Committee (“IRWC”) is tasked to track market interest rate trends, plan and manage product mix, product pricing and re-pricing strategies. The RMC meets periodically to review the interest rate repricing gap report and interest rate sensitivity analysis to ensure that they are within risk tolerance and limits set, and to make decisions on appropriate mitigation actions to be taken in anticipation of changes in market trends.

4. Market Risk. 

• Market risk is the risk that the value of a portfolio will decrease due to the change in the value of the market risk factors. The market risk factors are credit spreads, interest rates, equity prices, foreign exchange rates, commodity prices and their associated volatility. 
• SIF primarily adopts Value-at-Risk (“VaR”) and scenario based stress testing methodologies to measure market risk for its SGS and equity investments to ensure that they are within set risk tolerance levels. However, SIF does not participate in foreign exchange trading, and all foreign exchange contracted with bank counter-parties are on behalf of borrowers and are on secured basis, therefore, reducing its market risk factors. 
• SIF’s investment portfolio comprises mainly Singapore Government securities and securities listed on the Singapore Exchange Securities Trading Limited (SGX).

Forecast Assumptions 

1. Loans growth flat in FY17e but expected to pick up in FY18e 

• We expect loans growth to be flat as the pass through of higher rates to clients may dampen loans volume growth. We also do not expect changes to the uncollateralised loans business to have a meaningful impact on loans growth as it would on net interest income. 
• Moving into FY18e, we can expect better loans growth as benefits from uncollateralised lending activity flows through into the collateralised loans business.

2. Cost to Income Ratio improves from 50.4% in FY16 to c.48% in FY17e 

• In FY17e, we expect improved operating efficiency as total income growth is driven more from favourable interest rates and regulatory changes to uncollateralised lending but less from increasing loans volume which may require higher sales costs.

3. Loans volume growth from E-commerce opportunities is not factored in yet.

• Though E-commerce opportunities are rapidly progressing and highly visible, there remains insufficient information on the potential size and geographical footprint of loans that can be originated from the first-hand E-commerce market. Therefore we have not included any loans volume growth projections from the E-commerce opportunities in our FY17e and FY18e estimations.

Valuation and Peer Comparison 

• Based on the latest quarter results, we tabulated the dispersion chart for the banks and finance companies to find a linear relationship between their price to book ratio and their earnings yield as measured by their Return on Equity Ratio (“ROE”). Our view is that the banks and finance companies trade at a book value ratio which are positively correlated with their ROE.
• Though SIF is trading at +1 standard deviation of its 3-years historical price to book ratio, it is priced more conservatively according to the dispersion chart. We believe that SIF should be priced closer to 0.8 times price to book to be in line with its current ROE.
• As of 1Q17, SIF’s book value per share is S$2.09. At 0.8 times price to book, we expect SIF’s share price to be $1.670 per share. 
• As the target price is lower than the FY17e valuation price of S$2.34, we believe the target price is reasonable. The target price of S$1.67 represents an 18.58% upside (including FY17e dividends) from Sing Investments & Finance's current price of S$1.48.

Jeremy Teong Phillip Securities | http://www.poems.com.sg/ 2017-07-24

Phillip Securities SGX Stock Analyst Report ACCUMULATE Initiate ACCUMULATE 1.67 Same 1.67