The banking sector has moved back towards its fair value level over the last three months and hence in our view, can no longer simply be argued as ‘being cheap.’ This has resulted in us cutting our rating on Public Bank (“PBBANK,” MP, TP: RM16.80) and viewing Hong Leong Bank (“HLBANK,” MP, TP: RM15.20) as unexciting. Following the recent results season, our picks for the sector have changed for 2Q2013 centering on three key themes, i.e. 1) The laggards, 2) the defensives and 3) the dark horses. Under these themes, we like AMMB Holding (“AMMB,” OP, TP: RM7.40) as its share price has underperformed in 2012 and is now trading at the lowest point of its historical PER band as well as its P/BV band of the last five years. We expect the share price to play catch-up in 2013. We also like Maybank Bank (“MAYBANK,” OP, TP: RM10.90) as its domestic-driven model offers earnings visibility to investors together with a high 6.4% dividend yield. Lastly, we find AFFIN Holding Bhd (“AFFIN,” OP, TP: RM4.40) as the potential dark horse in the banking sector once the election fears dissipate since it should continue to benefit from the continuous improvements in its asset quality, earnings growth and its nature of being a high beta play. Thus, in conclusion, we are maintaining our OVERWEIGHT rating on the Banking sector.

The 4Q12 results trend and outlook saw the banking sector posting a marginal QoQ drop in earnings (-3.3%) with the underlying profit growth momentum having clearly stalled. Going forward, there are limited opportunities to drive the sector earnings growth materially beyond our current expectation of a high single digit growth for 2013 given the ongoing margin headwinds and limited credit charged surprises as guided by most bank managements. The 4Q12 results were also somewhat uninspiring for the market. Apart from the decline in capital market revenues, in our view, the weak quarterly profit growth through 2H2012 was actually due to higher expenses in some banks after their merger exercises and also the lack of a rise in their overall fee incomes. Non-interest incomes growth continues to be flat (+1.3% QoQ). We also expect the softer trading conditions to persist in the short term due to the on going election uncertainties. Earnings margins also saw signs of softness given that there was no interest rate hike in the short term (-9bps QoQ on average). We believe that bank’s margins will continue to face a modest headwind in 2013. The credit demand was strong, however (11% on average vis-à-vis the nominal GDP growth of 5.0%) despite the weak external outlook. Going forward, we are forecasting just a 9-10% credit growth to be driven by the ETP-related projects. Provisioning on new impaired assets has also fallen resulting in a lower credit charge.

Earnings growth is limited and valuations are stretched for certain banks. Given our view that the responsible finance policy of the Central Bank will promote a healthier household lending portfolio, the momentum of loan growth will be lower in 2012-2013 and hence, our base case for the system loan growth is maintained broadly in the low teens only at around 9%-10%. Together with the ongoing margin squeeze headwinds and tailwinds in low provisioning, there are limited opportunities to drive the earnings growth for banks from here materially beyond our current expectation of a high single digit growth only. With earnings growth in the range of high single-digit to low teens together with the already stretched valuations, we believe thus that a rise in the valuation multiple is also unlikely for the sector. The major banks’ valuations are already trading at above the average of their historical valuation range and as such, their valuations already considered “fair”. Given so, this will cap the absolute share price performance of banking stocks going forward especially for PBBANK and HLBANK.

M&A updates. Media news has recently reported that AFFIN and AMBANK are potentially serious bidders for Hwang-DBS Bhd. The equity broking landscape has certainly changed with the mergers of OSKIB+RHBIB and KNKIB+ECMIB in the last one year, where merger and acquisitions (M&As) have not happened since as far back as 2005 when CIMB acquired SBB. Our point of view is that this could be a push factor for commercial bank-backed IBs to kick-start their acquisition strategy so as to not lag behind their competitors. In our view, we believe that a 10% market share of the market will be required to stay competitive for the future.

On the market share front, Hwang has a 6.67% share (based on the YTD number until Feb 12), AFFIN IB has 3.19% and AmInvest has 7.18%. In contrast, the big players like RHB+OSK has the largest share of 9.69% followed in second place by CIMB’s 10.99% and KNKIB in third place with a market share of 10.38%. This shows that the gap has grown between the top three market share leaders and the fourth to six placed players by 1.58%-5.31%. We also believe that local banks are enthusiastic towards acquiring stock brokering business as part of their strategy due to the increasing focus on growing their fee-based income. An enlarged scale also presents opportunities for cost-saving and a more efficient supply-chain management, which helps in improving long-term operational efficiency.

Source: Kenanga