Public Bank’s share price has fallen 10% since our recommendation downgrade in early Jun-20 and we find that the stock is worth a relook. In our view, its risk reward profile seems more balance now as: (i) FS fell off its peak to a 5-year low, (ii) valuation is trading close to a decade low, (iii) strong asset quality will likely shine in times of uncertainty, and (iv) it is now offering forward dividend yield of >4%, which is c.1ppt above its 5-year average. Overall, forecasts were unchanged. Upgrade to HOLD and a higher GGM-TP of RM15.90 (from RM14.80), based on 1.25x FY21 P/B (from 1.15x).

Public Bank’s share price has fallen 10% since our rating downgrade in early Jun-20. This was owing to poor general investment sentiment towards banking stocks, given asset quality concerns and resurgence of domestic Covid-19 infections. In this write up, we reassess the risk-reward profile of the stock.

Depressed valuations & low FS. Public Bank’s foreign shareholding (FS) fell off its peak of 39.5% in Mar-18 and is now at 27.9% (5-year low). Valuation wise, the stock is trading close to a decade low P/B of 1.18x vs 2.28x during the global financial crisis and 1.53x at the start of 2020. With these, we find that the stock is worth a relook.

Conservative level of provision buffers. Public Bank’s strong asset quality will likely shine during times of uncertainty. In 2Q20, gross impaired loans (GIL) ratio improved 6bp QoQ to 0.40%; however, this was mainly thanks to the 6-month automatic loan moratorium, which masked the challenging credit climate. That said, management has raised pre-emptive provisions with net credit cost (NCC) rising to 19bp in 2Q20 from 8bp in 1Q20. For FY20, we have pencilled in NCC assumption of 25bp, being at the upper end of the 20-25bp guidance. From back-of-the-envelope calculations, this would suggest provisioning buffers built up for additional 1.0% GIL ratio to 1.4% (3.5x of current levels), which we reckon to be already very conservative.

Can be leaner. Although Public Bank has always been a lean machine, we believe it still has room to bring down opex and even possibly create positive Jaws during this tough operating environment; its current cost-to-income ratio (CIR) is 34% vs peers’ average of 47%. In our view, management can look to rein in discretionary spending such as reducing staff bonus, since Public Bank’s personnel cost to total opex is 72% while the sector is 10ppt lower. Regardless, guidance is lacking on this front and we have prudently built in FY20 CIR assumption of 36% into our financial model.

Final dividend likely intact. We are still expecting Public Bank to pay final dividend, despite not divvying in 2Q20; this is backed by resilient profits, comfortable 14% CET1 ratio, and robust asset quality with high loan loss coverage (incl. regulatory reserves) of 302%. Accordingly, we assumed a lower dividend payout ratio of 32% for FY20 but see it normalizing up to 51% for FY21, similar to FY19’s level. We note Public Bank’s 5-year average dividend yield is 3.0% and it is now offering forward yield of >4%.

Forecast. Unchanged.

Upgrade to HOLD (from Sell) and a higher GGM-TP of RM15.90 (from RM14.80), based on 1.25x FY21 P/B (from 1.15x) with assumptions of 10.7% ROE, 9.1% COE (from 9.6% to reflect the strength of its defensive qualities during times of uncertainty), and 3.0% LTG. This is above the sector’s P/B of 0.75x but beneath its 5-year mean of 1.92x. The premium/discount is justified given its ROE generation, which is 3ppt/4ppt over/below industry/its 5-year average. Overall, the stock’s risk-reward profile appears balance now, seeing its recent price weakness and valuation is undemanding (trading close to -2.0SD P/B).

Source: Hong Leong Investment Bank Research - 8 Oct 2020