OCBC (OCBC SP) - DBS Research 2017-10-25: GEH Results Stronger Y-o-y, Softer Q-o-q; Within Expectations

OCBC (OCBC SP) - DBS Vickers 2017-10-25: GEH Results Stronger Y-o-y, Softer Q-o-q; Within Expectations OVERSEA-CHINESE BANKING CORP O39.SI

OCBC (OCBC SP) - GEH Results Stronger Y-o-y, Softer Q-o-q; Within Expectations

  • Great Eastern Holdings (GEH) results were stronger y-o-y but softer q-o-q; within our expectations; underlying business stayed robust.
  • OCBC to release results on 26 October (am); watch out for NIM trends, non-interest income and provisions; small one-off gains from disposal of investments.
  • A number of events to take place by year-end including the completion of the acquisition of NAB, disposal of HK Life, and potential corporate exercise involving GEH Malaysia.
  • OCBC remains a BUY, Target Price at S$12.80.

What’s New 

GEH results stronger y-o-y but softer q-o-q; within our expectations. 

  • Although a softer 3Q17, Great Eastern Holdings’ (GEH) results were broadly within our expectations. The repeat of a strong 2Q17 was not expected. 
  • Favourable market conditions in 2Q17 saw GEH's non-operating income rise significantly; this however moderated in 3Q17. Overall gross premiums and profit from insurance operations were better y-o-y. 
  • On a q-o-q basis, the decline in earnings arose from lower non-par fund profits while there was an increase in its investment-linked fund profits, coupled with a slight decrease in par fund profits. Lower q-o-q investment gains also dented its quarterly earnings marginally.

Sustained strength in underlying business of GEH. 

  • GEH's underlying business was strong with total weighted net sales (TWNS) up by 16% y-o-y but new business embedded value (NBEV) fell by 10% y-o-y. NBEV margin however fell to 38% from 49% a year ago; there was a shift in product mix and agency channels mainly in Singapore. 
  • GEH’s Malaysian business saw NBEV improve y-o-y.

OCBC's results to be released on 26 October (before market opens). 

  • OCBC is due to release its 3Q17 results this Thursday before market opens. 
  • Taking the cue from GEH’s results, OCBC’s non-interest income should be decent. Although insurance income contribution would likely be lower q-o-q, this would be offset by the improved wealth management business during the quarter, which we understand, should remain strong. 
  • 2H17 non-interest income would likely be softer vs 1H17 in the absence of big fund launches. There will be small gains booked for the sale of its shares in United Engineers
  • There should be no surprises in its expense trends with cost-to-income ratio ranging at 40-45%. Its NIM however could be flattish. While SIBOR/SOR-related loans could start to see some repricing, its Hong Kong book may still dent NIM marginally due to the differential in the movement of its loan and deposit pricing (the relative movement of the 1-month and 3-month HIBOR).
  • Meanwhile, funding costs have been relatively competitive in Malaysia and Indonesia but benign in Singapore. Loan growth would likely be similar to 2Q17 which was around 2% q-o-q; OCBC is on track to achieve its mid-single-digit guided loan growth for the year, driven by trade finance and a strong pick-up in housing loans and regional corporate loans. 
  • OCBC’s exposure to the oil & gas segment has stayed relatively stable. Provisions are expected to be lower y-o-y but incremental specific provisions are likely q-o-q as collateral gets revalued. These are based on existing accounts already identified. Other portions of its loan book remain largely healthy. Capital levels are expected to stay strong.

Events/items to watch by year-end 

NAB acquisition; disposal of HK Life to be completed by 4Q17. 

  • Its acquisition of National Australian Bank’s (NAB) portfolio will likely only be completed and fully consolidated by end-FY17 but the impact would be small. Separately, the disposal of HK Life to be also likely be concluded by year-end.

Expect minimal impact from IFRS9 on Day 1 of adoption.

  • There should be minimal capital impact on the Day 1 of adoption of IFRS9 to capital. Provisions are believed to be largely adequate. Possible changes to the provision run rate will be clearer from 1Q18 trends.

Capital levels to stay robust. 

  • Among peers, OCBC is the only bank that has turned off its scrip dividend tap. It prefers to wait for clarity on Basel 4. However, there would be some capital uplift when OCBC-Wing Hang and OCBC NISP adopts the Internal Ratings-Based (IRB) Approach for its capital computation, potentially lifting capital ratios by 20- 30bps by the end of the year.

GEH exploring to “sell” its Malaysian operations, as reported. 

  • Great Eastern Holdings (GEH) is reported to have engaged at least one Malaysian bank to explore selling its stake in its Malaysian operations. It has also been noted that several other foreign insurance companies operating in Malaysia (including Prudential Malaysia and Tokio Marine Insurance Malaysia) could be exploring similar options. This move is in reaction to Bank Negara Malaysia’s (BNM) stricter enforcement of the 70% foreign ownership cap on insurers, which was issued back in 2009. 
  • We understand the timeline could be fluid, and negotiations could be managed on a case-by-case basis.
  • In our view, there are three viable options for these companies to pare down their stakes:
    1. List (IPO) 30% of their shares to the public;
    2. joint-venture with a local partner; or
    3. divest to local institutional investors. 
  • OCBC’s official stance on this is “GEH is exploring options to meet the necessary requirements”.

Valuation & Recommendation 

Maintain BUY, S$12.80 TP. 

  • OCBC is a BUY with Target Price at S$12.80 based on the Gordon Growth Model (11.5% ROE, 3% growth, 9.5% cost of equity) which is equivalent to 1.3x FY18 BV, its 10-year mean P/BV multiple. 
  • OCBC’s key differentiating factor lies in its insurance business which gives it a more holistic wealth management platform, which we believe is still under-appreciated by the market. 
  • Solid 2Q17 earnings was testimony of its non-interest income franchise. Asset quality issues pertaining to the oil & gas segment have been dealt with, and sufficient provisions are said to have been made. 
  • A visible improvement in asset quality contrary to stabilisation could be an added re-rating catalyst apart from better NIM, loan growth and non-interest income prospects.

Sue Lin LIM DBS Vickers | http://www.dbsvickers.com/ 2017-10-25
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