Although share price skidded 9% YTD, it is still not amply attractive to warrant a recommendation upgrade. In our view, the stock’s risk-reward profile remains balanced given long-term positives like strong asset quality and above average ROE generation track record got defused by short-term concerns like modest earnings growth outlook, unattractive dividend yield offering, and high foreign shareholding level (susceptible to sell-off). Overall, we cut our FY19-20 earnings forecasts by 2-3% and introduced FY21 estimates. Retain HOLD but with a lower GGM-TP of RM24.40 (from RM26.50), based on 2.15x 2019 P/B.

Public Bank is one of the worst performing banking stocks under our coverage as share price took a beating of 9% YTD. Major bugbears were: (i) fear of an OPR cut (but our economists think occurrence is unlikely unless the external environment deteriorates further), (ii) dim earnings outlook, (iii) rich valuations, and (iv) high foreign shareholding. Hence, we reassess our investment thesis and its risk-reward profile.

Top-line lacks oomph… Management telegraphed a downbeat outlook for 2019 as it is poised to grapple with a challenging macro climate. We believe the lurch will come primarily from weak revenue, which leads to negative Jaws and impact overall profitability. This year, we see a NIM slippage of 4bp vs the mid-single digit decline guidance (2018: -6bp) due to ongoing sector-wide rivalry for retail deposits. Besides, non-interest income (NOII) is not expected to be a top-line booster as we are projecting slow growth of 2% (2018: -5%); this considers: (i) tepid unit trust income as investor sentiment remains gloomy while (ii) muted loans growth (our expectation is <5%) and softer consumer spending trend, point to dull fee and commission income.

…instigating negative Jaws… With 2019 revenue growth seen to be subdued at 3% (2018: +1%) vs an opex inflation estimate of 5% (2018: +4%), negative Jaws should ensue. Also, Public Bank is now placing more emphasis on further improving its ICT and digital infrastructure to play catch up with peers. Over the next 3 years, IT-related capex is budgeted to rise by 50% vs RM400m spent from 2016-18. Overall, it has guided cost-to-income ratio (CIR) of 34-35% this year (2018: 33%); we have built in similar CIR assumption of 34% into our financial model.

…with NCC on the rise. Seeing the will to keep strong asset quality as part of its business growth strategy, 2019 gross impaired loans (GIL) ratio is expected to stay stable in the range of 0.5-0.6% (2018: 0.5%; guidance: <1%). Besides, high loan loss coverage (LLC) ratio of above 100% has allowed net credit cost (NCC) to continue to be at low levels (2018: 5bp). However, amid moderate economic expansion, we believe there is little room to narrow this even further. Thus, we imputed a slightly higher 7bp NCC assumption for 2019 (vs guidance of <15bp).

Forecast. We lower our FY19-20 earnings forecasts by 2-3%, chiefly from downward NIM adjustment (-4bp vs -1bp previously) along with higher opex assumption (+5% vs +3% previously). These aside, we updated our financial model post the release of its FY18 annual report. Also, we introduce our FY21 estimates.

Retain HOLD but with a lower GGM-TP of RM24.40 (from RM26.50), following our earnings cut and based on 2.15x 2019 P/B (from 2.36x) with assumptions of 13.4% ROE (from 13.8%), 7.8% COE, and 3.0% LTG. This is in line with its 5-year mean of 2.15x but above the sector’s 1.15x. The premium can be justified by its strong asset quality and ROE generation track record. Despite the 9% skid in share price, risk reward profile has not become convincingly attractive, plagued by (i) modest earnings growth outlook, (ii) unattractive dividend yield of 3% (peers: 4%), and (iii) high foreign shareholding level at 37.4% (vs Maybank: 19.5% and CIMB: 25.6%).

Source: Hong Leong Investment Bank Research - 12 Apr 2019