Period  2Q14/1H14

Actual vs. Expectations The reported 6M14 net profit of RM269.0m accounted for 46% of our forecast (RM580.0m) and 47% of consensus estimate (RM574.0m). Hence, we deem the results to be broadly within expectations.

Dividends  No dividend is declared during the quarter, which is within historical track records.

Key Result Highlights

6M14 vs. 6M13

 The 1H14 net profit merely grew 1.0% YoY while total income grew at a slightly faster pace of 3.1% YoY. The low single-digit growth in totol income was due to the lacklustre growth in net interest income of 3.4% YoY and a 15.1% YoY decline in Islamic banking income. This decline has offset the mid-teen YoY growth rate of 15.9% in non-interest income.

 We understand that the less exciting net interest income growth was due to further NIM compression of c.20bps. The continuing margin compression has been owing to (i) run-off from repayments of higher yielding loans such as coop loans, (ii) new mortgage loans at lower yields, and (iii) intensified competition for fixed deposits.

 This negative factor, however, was cushioned by the YoY growth in total loans of 12.6% vis-à-vis our estimate 9.4% and industry of 9.5% as at end-Sep13. The strong growth in total loans was driven by targeted profitable consumer loans that grew 18.9% YoY and accounted for 57% of the entire loans book. This segmental loan includes share (>100% YoY) and auto financing (+60.1% YoY) as well as mortgages (+17% YoY).

 Customer deposit growth of 14.3% YoY was almost matching the loans growth hence loan-todeposit (LD) ratio was maintained around 81% (1H14: 80.5%, 1H13: 81.3%).

 We understand that the weak performance of Islamic Banking income (-15.1% YoY) was due mainly to the run-off of high yield Co-op personal financing. Non-interest income, on the other hand, accounted for c.29% of the total income growing 15.9% YoY from c.26% contribution in 6M13. While this income contribution was meeting the management target of 30%, the growth was mainly due to a one-off RM30m bancassurance fee in 1Q14. However, this fee contribution was offset by a RM23.2m lower investment income compared to 1H13 due to steeping of yield curves that caused (i) lower gains from sales of AFS and (ii) lower valuation of derivative instruments. Excluding these lumpy amounts, the non-interest income was driven by transaction banking, wealth management, brokerage and treasury activities.

 Cost-to-income (CTI) ratio remained flat at 45.9% vs. 45.5% in 6M13. Personnel cost remained the main operating cost, accounting for 66% of the entire OPEX. Excluding an on-off staff rationalisation expense of RM22.3m incurred in 1Q14, personnel cost should only account 63% of OPEX and the CTI ratio would have lower at 43.7%.

 Annualised credit charge/ratio was almost “zero” in 1H14 due to intensified recoveries as opposed to write-backs of 12bps in 1H13. At the same time, we also observed that gross impaired loan ratio improved substantially to 1.75% from 2.26% in 1H13. However, loan loss coverage was still hovering around 86.50% (vs. 86.43% in 1H13) and is below industry average of ~100%.

 Annnualised ROE was registered at 13.1% vs. 13.8% in 1H13 (and our estimate of 13.9%).

2Q14 vs. 1Q14

 In a nutshell, 2Q14 results were slight weaker as compared to 1Q14 with net profit declined 4.8% QoQ despite registering lower OPEX (-17.5% QoQ due to a one-off staff rationalisation expense of RM22.3m incurred in 1Q14) and net writebacks of RM4.84m (vs. allowances of RM5.37m in 1Q14).

 The weaker profitability was mainly driven by sharp decline in non-interest income (-44.1% QoQ), which caused total income declined 13.6% QoQ. This is because group enjoyed one-off bancassurance fees in 1Q14 and 2Q14 was further hit by lower investment income due to steeping of yield curves.

Outlook  We believe net interest income should remain steady driven by decent loans growth of ~10%-9% for FY14-FY15 despite that NIM could continue to be under pressure. In our forecast, we have factored in NIM compression of 5-6bps for FY14-FY15.

 As for non-interest income, we understand that the management aims to increase this segmental income to 30% of total income. Even if we assume the management to be able to achieve this target, we estimate the segmental income may only contribute 29% of the total income in FY14. However, if this earnings momentum to spill into FY15, this segmental income could achieve 32% contribution to total income.

 We also understand that the management target to improve its CTI ratio closer to the industry average of 45%-48%. We believe this could be achievable judging from its 1H14 number of 47.0%. In fact, in our forecast, we estimate that the ratio to register at 47.4%-45.1% for FY14-FY15.

 While these are no guidance over its credit cost, we believe the trend of writebacks should gradually reversal given that LLC of the group remains below industry average.

 The Group is also targeting to achieve ROE between 14% and 16%. However, judging from our estimates this could be an uphill task for the next 2 years.

 We also imputed a dividend payout ratio of 50% for the next 2 years. Note that this payout ratio is in-line with the management target as well.

Change to Forecasts Based on the afore-mentioned assumptions, we have fine-tuned our FY14 earnings estimate (lower) from RM580.0m to RM540.5m, representing a downward revision of 7%. However, our FY15 net profit estimate of RM598.5 remains unchanged.

 Our ROE forecasts are pegged at 13.0% and 13.4% for FY14 and FY15 respectively.

Rating Upgrade to OUTPERFORM from MARKET PERFORM.

 Despite our downward revision in FY14 earnings, we are upgrading our call from MARKET PERFORM to OUTPERFORM as the stock could potentially offer >13% upside from here after it corrected ~14% from its 52-week high of RM5.77 since mid-2013.

Valuation  After rolled over our valuation base year to FY15, our Target Price (TP) has only revised from RM5.60 previously to RM5.62.

 Our TP is based on FY15 PER of 14.5x (vs. 15.0x previously) and 1.9x FY15 PBV (vs. 2.0x previously). The lower price multiples are justified as these valuation multiples already at the higher end of its valuation bands.

Risks  Tighter lending rules and further margin squeeze in general.

 The relatively low LLC ratio against the industry could be a treat to our credit cost assumptions.

 There is also risk to its valuations as it has been trading between 12x-15x PER or 1.5x-1.7x PBV for the last 4 years. Should the stock valuation reverse back to these means, we could see a significant stock de-rating.

Source: Kenanga