OCBC - DBS Research 2019-08-05: Dividend Increase Welcomed

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OVERSEA-CHINESE BANKING CORP (SGX:O39)

OCBC - Dividend Increase Welcomed

Remains cautious, maintain HOLD with Target Price of S$11.50.

• We maintain our HOLD call on OVERSEA-CHINESE BANKING CORP (OCBC, SGX:O39) as we remain cautious over its non-performing assets (NPA) coverage, which at 78% remains the lowest among its peers, even after additional provisions written in 1Q19.
• Though OCBC now has the highest CET1 ratio among peers (1Q19: 14.2%) post turning on its scrip dividends, its dividend yield continue to lag peers’ after 2Q19’s increase in interim dividends declared.
• We are of the view that OCBC’s dividend policy will continue to weigh on its near-term share price performance as management has maintained the need for strong capital levels amid volatile markets as well as for market opportunities (for instance, acquisitions) should they arise. See OCBC's dividend history.
• We are also cautious on execution risks in relation to acquisitions should they materialise.

Where we differ:

• We remain cautious that market volatility will continue to weigh on non-interest income.

Potential Catalysts:

• Higher dividends. OCBC currently trades at c.1.1x FY20F P/BV, near 1SD below its average 10-year forward P/BV multiple. A higher dividend payout ratio for OCBC, closer to its peers’ c.50%, could be a re-rating catalyst.

WHAT’S NEW - NIM uptrend continues on loan repricing

Decent set of results.

• OCBC reported 2Q19 net profit of S$1,223m (+1% y-o-y/-1% q-o-q). This was within our expectations but ahead of consensus by c.4%. Earnings were driven largely by higher net interest income and non-interest income, dragged by lower GEH contributions attributed to decline in discount rate for long-term insurance contract liabilities valuation which offset better investment performance.
• Cost-to-income ratio was higher at 44.0% (1Q19: 40.9%) as expenses growth (+11% y-o-y) outpaced income growth (+6% y-o-y). 2Q19 expenses included a one-off expense accrual reversal in 2Q18.
• NIM uptrend continues on loan repricing. Net interest income of S$1,588m improved 10% y-o-y/4% q-o-q, as NIM continued to improve, by 3bps to 1.79% largely on the back of higher asset yields in Singapore, Hong Kong and China (1Q19: 1.76%).
• Malaysia saw NIM compression during the quarter on higher cost of funds.

Wealth management continues to see strong growth.

• Non-interest income of S$1,030m was largely flat at +1% y-o-y/-10% q-o-q. While wealth management saw strong growth on the back of higher AUMs, lower trading income and GEH contributions dragged non-interest income on a quarterly basis.

Loan growth continues.

• Loan book grew 4% y-o-y/2% q-o-q, led by building and construction loans. Deposits grew 2% y-o-y/1% q-o-q boosted by higher CASA deposits, while LDR was higher at 87.6% (1Q19: 87.1%).
• In 1H19, loan growth was driven by en-bloc deals’ loan drawdown in Singapore as well as corporate actions arising from Singapore corporates, on top of overseas property investments.

Normalised credit costs after 1Q19’s higher credit costs.

• Total credit costs for 2Q19 was lower at 15bps (1Q19: 35bps, FY18: 11bps), special provision charges were lower at 13bps (1Q19: 32bps). Taking into account 1Q19’s higher credit costs in relation to oil and gas portfolio, total credit costs for 1H19 was at 25bps (full-year guidance: closer to 19-22bps).

New NPA formation increase in relation to an Indonesia exposure.

• NPL ratio was flat at 1.5% (1Q19: 1.5%) with higher new NPA formation at S$390m (1Q19: S$298m).
• According to OCBC, the increase relates to its CPO portfolio in Indonesia which suffered from lower CPO prices. However, special provisions are mostly unrequired due to sufficient collateral. The portfolio represents c.2% of the group’s portfolio.

Strong capital levels; higher dividends.

• Capital levels stood strong with CET1 ratio at 14.4% (1Q19: 14.2%) and total CAR at 16.8% (1Q19: 16.7%). ROE for 1H19 was 11.7% (FY18: 11.5%). A higher interim dividend of 25 Scts was declared (2Q18: 20 Scts/ FY18: 43 Scts) which represents a c.43% dividend payout ratio, an improvement from FY18’s figure. Scrip dividend continues to apply to the interim dividend and will be set at a 10% discount (unchanged from 2Q18). See OCBC's dividend history
• According to OCBC, the bank seeks to maintain a 25-Sct final dividend at least.

Key takeaways from analyst briefing

Continues to expect slight uptick in NIM in 3Q19.

• OCBC continues to expect a slight uptick in NIM through 3Q19 as its portfolio continues to reprice. Currently, OCBC expects to see a flat NIM in 4Q19. As FY18 NIM was at 1.70% and 1H19 NIM was 1.79%, we believe OCBC’s NIM is likely to end FY19 with a strong uptick of >6bps.

Maintaining loan growth guidance of mid-single digit.

• Year-to-date (since Dec-18), loan growth was +1.9%. OCBC continues to maintain its loan growth guidance of mid-single digit and believes that cross-border flows will continue to drive loan growth. OCBC remains cautious on the possibility of a massive uptick of mortgage loans in 2H19.

Retaining capital for defensive and offensive reasons.

• As of 2Q19, CET1 ratio stood at 14.4%, the highest among peers. While we believe that OCBC has the ability to pay higher dividends, management has reiterated the need for strong capital levels amid volatile markets as well as for market opportunities (for instance, acquisitions) should they arise.
• Within China, OCBC is awaiting further clarity on regulations in relation to relaxation of foreign ownership in a local bank. At the same time, OCBC believes there also exist opportunities beyond China.

Valuation and recommendation

Maintain HOLD; Target Price at S$11.50.

• While OCBC has increased its interim dividend to 25 Scts for 2Q19, we believe its dividend policy is still likely to weigh on its share price performance in the near term. Further, should inorganic opportunities arise, there may also be associated execution risks. See OCBC share price & OCBC's dividend history
• We arrive at our revised S$11.50 Target Price based on the Gordon Growth Model (12% ROE, 3% growth, 11% cost of equity). This is equivalent to c.1.1x FY20F P/BV, which is below its average 10-year forward P/BV multiple.

Rui Wen LIM DBS Group Research | https://www.dbsvickers.com/ 2019-08-05

SGX Stock Analyst Report HOLD MAINTAIN HOLD 11.500 SAME 11.500