ESG investing is rapidly gaining prominence. Studies have revealed conscious capitalism can help to reduce portfolio risk and churn better returns. Based on our analysis, Maybank posted the highest ESG grade while Alliance was bottom of the rankings. However, we saw improving ESG scores YoY for majority of the banks under our coverage. Maintain OVERWEIGHT on the sector. We have BUY calls on Maybank, RHB, and BIMB (the trio has high ESG ratings).

The changing world order. ESG investing is rapidly gaining traction. Studies have shown conscious capitalism can help to reduce portfolio risk and churn better returns. For the environmental (E), it requires scrutiny on the company’s impact and upkeep of the natural world. As for social (S), it takes into consideration of people and relation ships, both within the company and in larger society. Lastly, governance (G) involves the standards for running a firm relating to oversight, board of directors, and business integrity. Top material issues for the banking sector, include: (i) commitment to green and sustainable financing, (ii) privacy & data security, (iii) human capital management, (iv) financial inclusion, (v) corporate governance, as well as (vi) business ethics.

ESG scores. We chose key focus areas that have quantifiable ESG data to work with and identified 16 parameters to analyse (we will eventually add more when newer and relevant info becomes available). Based on our analysis, Maybank posted the highest ESG grade of 4 (out of 5) while Alliance was bottom of the rankings with only 2 points; the former excelled in areas of social & governance, whereas the latter was dragged by low scores at the environmental & social segments. That said, we saw YoY points improvement among banks (Affin & Public Bank gained traction at the social category while Alliance, AMMB, CIMB & Maybank boosted their governance ratings), with the exception of BIMB and RHB (both bruised by lower marks for governance).

Connecting the dots. On average, the top 3 ESG scoring domestic banks (Maybank, Public Bank and BIMB) outperformed KLFIN by 17%, 24%, and 170% in the past 3, 5, and 10 years. Moreover, they are trading well above 1.0x P/B and the sector mean of 0.9x. While is evident ESG investment can give additional alpha returns, one must still diligently incorporate traditional financial analysis into their decision-making process. For banks’ valuations, we dissected the GGM-model and find that good ESG practices can lead to higher profitability, which help to drive up ROE as well as LTG. Looking at the top 3 ESG graded banks, all of them have above average ROE output and P/B valuations. In general, valuations of banks are still mainly based on tangible assets (measurable in nature) and remain largely dependent on stock fundamentals for price discovery (by employing ROE and LTG with ESG acting as a supplement).

Maintain OVERWEIGHT. Banks have seen the pros of addressing ESG issues and it goes far beyond public relations. Good ESG practices have shown to exhibit less risk and greater financial performance over the longer-term. Thus, the level of commitment towards ESG has been growing; we noticed improving trajectory in ESG scores for majority of the banks under our coverage. With current undemanding valuations, we believe this is an opportunity to accumulate banking stocks. For large-sized banks, we like Maybank (TP: RM9.20) over Public Bank (TP: RM4.25) and CIMB (TP: RM4.50); Public Bank has rich valuations, higher foreign shareholding, and lower dividend yield while CIMB is a riskier proposition given less resilient asset quality. As for mid-sized banks, RHB (TP: RM6.65) is preferred over AMMB (TP: RM2.95) since the latter may have to contend with negative perception issues. For small-sized banks, BIMB (TP: RM5.00) is favoured vs Affin (TP: RM1.85) and Alliance (TP: RM2.90), considering its positive long-term structural growth drivers and better asset quality. Looking at our BUY recommendations, the trio (Maybank, RHB, BIMB) has high ESG ratings (based on our scoring methodology) in their respective divisions.

Source: Hong Leong Investment Bank Research - 24 Mar 2021