Period  3Q14/9M14

Actual vs. Expectations The reported 9M14 net profit of RM405.5m (+1.6% YoY) accounted for 75% of our forecast (RM540.5m) and 71.6% of consensus estimate (RM566.2m). Hence, we deem the results to be broadly within expectations.

Dividends  Proposed a 2nd dividend of 11.5 sen raising the YTD dividend to 19.0 sen which is slightly higher than our estimate of 17.5 sen.

 The Group still maintain a 50% dividend payout policy.

Key Results Highlights

9M14 vs. 9M13

 The 9M14 net profit merely grew 1.6% YoY while total income grew at a slightly faster pace of 3.0% YoY. The low single-digit growth in total income was due to the 14.3% YoY in Islamic Banking Income resulting from run-off of higheryielding co-op loans. However, it was cushioned by the decent growth in net interest non-interest income that grew 6.4% and 8.6%, respectively.

 Nonetheless, the growth in net interest income was lower than the gross loans growth of 12.8% (vs. our estimate of ~10.0% and industry of 10.6% as at end-Dec13) due to continuing margin compression in NIM. YTD, NIM dipped 26bps from 2.52% to 2.26%. This declining trend is due to: (i) new mortgage loans at lower yields and (ii) intensified competition for fixed deposits.

 The strong growth in total loans was driven by targeting profitable Consumer (+18.6% YoY) and SME (+8.3%) segments. This segmental loan includes share (+82.2%) and auto financing (+57.0%) as well as mortgages (+17.5%). Besides, lending to construction sector also saw a 26.5% YoY growth.

 Customer deposit growth of 17.1% YoY kept pace with loans expansion to maintain a healthy loans-to-deposit ratio (LDR) of 83.6% (vs. 86.7% as at end-Dec12). We understand that the group is targeting to eventually raise LDR closer to 85.0% for more efficient balance sheet management. In fact, should this be achieved via higher CASA composition, the banking group may see better NIM. Thus far CASA deposits grew 7.5% YoY, contributing to 35.2% of total deposits (vs. 38.3% as at end-Dec12), which is higher than industry average of 26.5% as at end-Dec 13.

 Non-interest income, on the other hand, accounted for c.27% of the total income (vs. c.26% contribution in 9M13). It seems that this segmental income contribution is on track to meet the management target of 30%.

 Thus far, the growth was driven by: (i) recurring income from transaction banking, wealth management and brokerage activities and (ii) a one-off sign-on fee from bancassurance arrangement amounting to RM30m. However, investment income from Financial Markets registered RM25.8m YoY drop due to steepening of the yield curves.

 Cost-to-income (CTI) ratio continued to improve (from 9M13: 47.8% to 9M14: 45.9%) due to effective cost management as the Group continues to invest in IT infrastructure. Operating overhead expenses declined 1.0% YoY, despite a one-off staff rationalisation cost of RM22.3m incurred in 1Q14.

 We saw a trend of normalisation in allowance/write-back of losses on loans due to strong loans growth. YTD, the Group registered RM4.0m provisions (or <2bps in credit charge ratio) as opposed to RM28.7m write-back in 9M13. Provision charge of RM3.1m was incurred as compared to net write-back of RM29.2 million last year. Nonetheless, loan loss coverage (LLC) improved to 91.2% from 83.8% in end-Dec12 due to higher recoveries of impaired loans. However, the LLC is still below industry average of 107.6% as at end-Dec 13.

 Tier 1 ratio and Total Capital ratio were registered at 11.8% and 14.4% respectively. These ratios are way above the Basel III minimum requirement of 6.0% and 8.0% for calendar year 2015 despite slightly below the industry averages of 12.9% and 14.3% as at end-Nov 13.

 Annnualised ROE was registered at 13.4% (vs. 13.6% in 9M13 and our estimate of 13.0%).

3Q14 vs. 2Q14

 In a nutshell, 3Q14 results have shown improvement despite seeing normalisation in allowance/write-back of losses on loans (RM3.4m loan loss provisions in 3Q14 vs. RM4.8m writebacks in 2Q14.

 We saw improvements in terms of top-and-bottom-lines. Total income and net profit grew 4.4% and 4.0% QoQ respectively while operating expense were flat (-0.4% QoQ).

Outlook  Going forward, the management expects net interest income to remain steady driven by decent gross and net loans growth rates of ~10% and 13%, respectively. However, as we expect some slowdown in the consumer space arising from tighter regulations, we have imputed a milder loan growth of 9% in our FY15 numbers.

 While NIM is expected to be under pressure, the degree of compression could be milder judging from this set of results. NIM seems has stabilised with a 3bps improvement in 3Q14 as opposed to 2Q14. In our forecast, we have factored in NIM compression of 5-6bps (vs. ~30% YTD) for FY15.

 If the growth momentum of non-interest income spills into FY15, we believe this segmental income should achieve the management’s target of 30% to total income.

 We also understand that the management is targeting to improve its CTI ratio closer to the industry average of 45%-48%. We believe this could be achievable judging from its 9M14 number of ~46.0%. In fact, we estimate that the ratio to register at 45.1% in FY15.

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

 Judging from our FY15 earnings estimates and a dividend payout ratio of 50%, we believe it could still be an uphill task for AFG to achieve its ROE target of 14%-16%. Our FY15 ROE estimate is pegged at 13.4%.

Change to Forecasts

 No change in our FY14 and FY15 earnings estimates which remain unchanged at RM540.5m (+0.5% YoY) and RM598.5m (+10.7%), respectively.

 Both of our FY14 and FY15 earnings estimates are lower as opposed to consensus’ forecast of RM566.2m and RM617.5m, respectively.

Rating Maintain OUTPERFORM as the stock could potentially offer ~19% upside after it corrected ~18% from its 52-week high of RM5.77 since mid-2013.

Valuation  Our Target Price (TP) of RM5.62 is based on FY15 PER of 14.5x and 1.9x FY15 PBV.

 These price multiples are at the higher end of its valuation bands.

 However, these price multiples are justifiable as we see greater earnings growth in FY15.

Risks to Our Call  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 a 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