We continue to favour the non-bank financial sector. YTD, both our top picks in 1H2012 i.e. Malaysian Building Society ('MBSB') and AEON Credit ('AEONC') have generated good returns for investors on the back of encouraging profit growth.  We continue to maintain our Overweight rating on the Non-Bank Financial sector and adding in Pacific & Orient ('P&O') as well into our OUTPERFORM list. We also currently choose P&O as the top pick for the sector for 2H2012.  Our calls on the sector are now P&O (OP, TP: RM1.30), MBSB (OP, TP: RM2.70), AEONCR (MP, TP: RM10.00) and LPI (OP, TP: RM15.80). 

The Malaysian Insurance sector is undergoing a major consolidation. This development offers opportunities for foreign insurers to have a new presence in Malaysia as well as local top firms to scale up their market shares. We have identified P&O as the next M&A play within this M&A theme.  We do not discount the possibility of a competitive bidding war as acquisition opportunities turns scarce after AmG proposed to acquire Kurnia Insurans. This should drive up P&O's valuation over the next 1-2 years based on the recent and upcoming acquisition valuation parameters. That aside, the group already has a well-established distribution network, a niche client base and a strong balance sheet.  The current and next two years will see the group's earnings jumping up by a 3-year CAGR of 14% (FY11-FY14), driven by huge profits from the group's motorcycle premium operation, which benefited from the 2010's surge in premium rates. We also would like to highlight that P&O is now trading at a low 0.77x FY13 P/BVand at just 3.0x PER with a superb 27% ROE. The icing on the cake is the potential higher dividend payouts, as  P&O is starting to manage its capital. The group's strategy is to maintain a strong and robust capital position in supporting the overall group's business growth and to deliver excess returns to shareholders.  We do not discount the possibility of its share price repeating the success of Syarikat Takaful Malaysia. Our Target Price of RM1.30 values the group at an undemanding FY13 PER of 5.0x, which is at the low end of the 5.0-15.0x 2012/13 PERs of Malaysian general insurers.

We have downgraded AEONC to MARKET PERFORM recently on valuation ground.  The group's loan growth and credit quality outlook remain intact according to management, underpinned by its strong merchant distribution platform. Going forward, we view a 30% loan growth target in FY13 as achievable with a favourable outlook for its (i) Credit Card, (ii) Personal Finance and (iii) Motorcycle Financing divisions.  This should result in an impressive 39% earnings growth in FY13. However, we think the current share price could have priced in  the strong earnings growth already. At the current level, the stock offers a potential capital downside of 5% but this is offset slightly by a dividend yield of 3.2%, which brings the potential total return to a  negative 2% over the next 12 months.  We are maintaining our target price of RM10.00 based on a targeted PER of 9.0x over its FY13 EPS of 111.1sen. 

No change in our call on MBSB and LPI. MBSB is still aiming to disburse a total of RM8.0b of PF-I loans. 1Q's RM2.9b in loan disbursement already made up 36% of its full year target. Hence, we believe its balance sheet expansion story remains intact. The stock's valuation still looks ndemanding at 5.9x PER post-adjustment against its banking peers of 13.0x. It also offers a 2.5% net dividend yield.  We maintain our target price at RM2.70 based on a targeted P/BV of 1.6x FY13 BV of RM1.70. Its ROE of 28.1% remains one of the highest for financial stocks. We believe LPI's faster-than-industry organic growth is sustainable and its earnings have more rooms to grow. Its business cash generation remains the strongest in the sector with an expected RM195m in FY12, which makes it a compelling dividend play story. Apart from the strong rise in its cash pile, positive news is that PBBANK does not need to raise new capital anymore under the new Basel III capital requirement. This could make LPI a good dividend paymaster going forward especially since it has no acquisition plans in place in the short term. We estimate that this will free up a total of RM80-90m in capital over the next few years. We reckon that LPI could return this excess cash pile to shareholders but are only estimating conservative assuming a payout ratio of 90% for FY12-14. We reckon that our assumptions are achievable as the payout ratio in FY11 had surpassed 100%. Based on our estimates, LPI could potentially pay out RM0.79-RM1.21 for FY12-FY14, translating into net dividend yields of  6%-9%. In addition, the deployment of its surplus cash will also provide a lever to improve its ROE.

Source: Kenanga