SG Banking Sector - OCBC Investment 2019-03-26: It Still Sparks Joy

SG Banking Sector - OCBC Investment Research | SGinvestors.io DBS GROUP HOLDINGS LTD (SGX:D05) UNITED OVERSEAS BANK LTD (SGX:U11)

SG Banking Sector - It Still Sparks Joy

  • Record year in FY18.
  • Another record year for FY19.
  • DBS is our pick.

FY18 was a stellar year for banks

  • 4Q18 results for all 3 banks were down, but this was not a complete surprise considering that global market was weak in the final quarter of 2018. As a result, the 3 banks reported -7% to -26% q-o-q decline in 4Q18 earnings.
  • Nonetheless, full year earnings were at record highs for all 3 banks, ranging from UNITED OVERSEAS BANK LTD (UOB, SGX:U11)'s net profit of S$4,008m to DBS GROUP HOLDINGS LTD (SGX:D05)'s net profit of S$5,577m.

Share prices were lackluster despite market rally

  • Last year, the STI fell 9.8%, while the FTSE ST Financials Index (FSTFN) dropped 8.7%. Even with the recent gains in the market in 2019, the indices have not recovered to the 2018 highs in May 2018.
  • The STI is 12.6% away from the 2018 high. At the 2018 high, the FSTFN was trading at 14.3x forward earnings and price-book of 1.2x. This has now dropped to about 1.0x book.
  • The lackluster performance so far this year could partly be due to expectations of lower fee income as well as expectations that there is not going to be any further Fed rate hike for the rest of this year.
  • With another record year projected for FY19, albeit at a lower single-digit growth in terms of earnings, it is not unreasonable to expect the index to trade back to the norm or the 10-year average of 1.1x book.
  • Similarly, with projected record earnings in FY19, it is not unreasonable to expect a re-rating of the banking stocks back to the 10-year average, pending no deterioration in market conditions.

DBS is our pick for the sector

  • Currently, the banks are trading at between 1.1 to 1.3x or an average of 1.2x historical book. If we raise the average to 1.3x book, together with a 10% premium for DBS over the other two banks which has been the case in recent years, this will bring estimated fair value estimates to quite similar levels as our projected fair value estimates for DBS and UOB.
  • Our fair value estimates are
  • At 25 March 2019 closing prices of S$25.12 and S$24.95, DBS is trading at 1.3x book and UOB is at 1.1x. In addition, dividend yields are 4.8% for both. 

NIM will be the focus this year 

  • After hitting a low in late 2016, Net Interest Margin (NIM) has been on an uptrend. In 4Q18, NIM ranged from 1.72% to 1.87%.
  • Based on guidance, most banks are expecting NIM to edge up slightly in 2019. This will largely be supported by the re-pricing of loans, which have already started in late 2018. Based on the SIBOR 1-mth rate, rates have been trending up from 1.517% at end Sep 2018 to 1.763% at end 2018.
  • Currently, the rate is at about 1.823%. We expect this to be positive for the banks, especially in terms of interest income. We are projecting a 9.3% rise in net interest income for DBS and a 7.4% rise for UOB in FY19. As a result, we expect the Net Interest Income to account for 68% of total revenue in FY19, up from 63-64% in FY16 and FY17.
  • Similarly, we are expecting the same trend for UOB. For UOB, we are expecting Net Interest Income to form 68% of total revenue versus 62% in FY16 and FY17.
  • Coming from the y-o-y decline in FY18 and a lower base effect, and buoyed by better market conditions so far this year, we are expecting Non-interest Income, largely trading and fee income, to also show improvements this year. 

Carmen Lee OCBC Investment Research | https://www.iocbc.com/ 2019-03-26
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