Yesterday, CIMB, RHBCAP and MBSB officially announced that they are ceasing discussions to merge, confirming earlier media reports. With this, we have decided to upgrade RHBCAP (TP: RM9.35) to OUTPERFORM and cut MBSB’s TP to RM2.65 (from RM2.82, OP). No changes were made to CIMB (OP; TP: RM6.27). Taking a cue from this development, we are of the view that there is lower likelihood to see any other domestic merger efforts in the short-run. We keep our NEUTRAL view on the sector as it still lacks rerating catalysts.

Proposed merger between CIMB-RHBCAP-MBSB is off. Yesterday, CIMB, RHBCAP and MBSB officially announced that they are ceasing discussions to merge, confirming media reports earlier this week on the matter. Essentially, the proposed deal was called off due to limited value creation as current economic condition is poor, disallowing potential synergies to be realised. Hence, we reviewed our recommendation on the three stocks.

CIMB (CIMB MK; OP↔; TP↔ RM6.27 based on 1.35x FY15 P/B). Although CIMB’s share price had rallied 11% since the merger was reportedly called off, it is still trading at 1.2x FY15 P/B vs. its 5-year average P/B of 2.0x (sector average: 1.6x FY15 P/B). Also, it is trading very close to its trough P/B of 1.0x which was last seen back in 2008 during the global financial crisis (GFC). Hence, in our opinion, the current depressed valuation is unwarranted given that nothing of such magnitude is brewing at the moment. Additionally, pressure from foreign selling should be capped for now as it has fallen from a recent high of 42.7% in May 2013 to 32.7% in Dec 2014 (GFC’s low 31.6%). That said, management had guided that 4Q14 will be a lethargic quarter (due to more loan loss provisioning for its coal & coal-related loan portfolio at Indonesia). As for its outlook for 2015, growth is also expected to be muted as weak capital market conditions are not favourable to the company. For now, we keep our OUTPERFORM call on the stock and TP at RM6.27, pending a group meeting with management next week.

RHBCAP (RHBC MK; OP↑; TP↔ RM9.35 based on blended PB/PE ratio of 1.2/10.7x). Now that the proposed merger has been aborted, we revert back to our conviction that RHBCAP is an OUTPERFORM, especially given its recent share price weakness. At current depressed level, our TP of RM9.35 implies a hefty total potential upside of 26%; we derive our TP based on a blended P/B of 1.2x and P/E of 10.7x. The P/B ratio applied takes into account RHBCAP’s share price performance when its return on equity hovered about 11-12%, while the P/E ratio applied is within its 3-year historical range of 10-11x. There is, however, a risk that our assumed 30% dividend pay-out will not be met (nil pay-out this year pending clarification from authorities of the Group’s capital adequacy). Should that be the case, upside will be a lesser 22%, which still is very compelling. The Group will be directing its focus to the mass affluent market, underserved in FY15, partly through the offer of next generation digital offerings. It is also looking to drive significant growth in Singapore.

MBSB (MBS MK; OP; TP↓ RM2.65 based on blended PB/PE ratio of 1.5/9.1x). We were caught by surprise that the proposed merger of CIMB Islamic, RHB Islamic and MBSB was also called off, given that the proposed creation of the mega-Islamic bank was independent of the CIMB-RHBCAP merger and acquisition. Since the deal is a no-go, we are reverting to our former TP of RM2.65, which was derived based on a blended PB/PE ratio of 1.5/9.1x. The P/B ratio applied is 2SD below the group’s 2-year mean in anticipation of lower ROE of 21.6%/17.5% for FY14/FY15 vis-à-vis its 3-year range of 34%-43%. The P/E ratio, on the other hand, represents the group’s historical average P/E ratio up to end-2013. To recap, we are expecting diversification into the corporate business lending segment which seems to be showing promise with corporate loans stock at end-Sept 2014 standing at RM4.8bn. Asset quality, however, remains a concern. Nevertheless, management appears committed to enhancing its asset quality especially in the personal financing segment. Hence, the GIL ratio may improve (9M14: 7.5%). At current share price levels, such concerns would have been fully factored in, in our view.

Implying lower likelihood for other domestic merger talks in the offing? Since the merger between the trios had fallen through, MAYBANK might now grab the opportunity to launch an immediate bid for RHBCAP, having expressed their interest to do so, weeks before CIMB struck an exclusive agreement with RHBCAP-MBSB to discuss on the proposed merger back in July 2014. However, taking a cue from this merger development, there is only a slim chance that this would pan out, reason being most of the synergies are cost derived and hence, value creation is limited for now. Recall for CIMB-RHBCAP-MBSB’s case, potential cost savings make up 86% of total synergies. Furthermore, Aabar Investments PJSC will continue to be a major stumbling block in any merger attempt with RHBCAP given its large shareholding of 21.2% in the latter. Hence, face with a low likelihood of success and possible gestation period during the initial stage of the merger, we opine that MAYBANK is unlikely to undergo this exercise. Following the same thought process, we are of the view that there should not be any other domestic merger efforts in the offing.

Maintain NEUTRAL. All in all, no changes to our NEUTRAL view on the sector. Structural and cyclical headwinds such as: (i) muted loans growth, (ii) narrowing net interest margin, (iii) weak capital market activities, and (iv) higher credit costs are expected to be seen this year. For individual stock picks, besides the trios, our other OUTPERFORM recommendations are BIMB (TP: RM4.72), MAYBANK (TP: RM10.13), and PBBANK (TP: RM18.89); we like the first two for their decent dividend yield offerings of 4%-6% while the third is for its defensive qualities. The remaining stocks under our coverage are MARKET PERFORM.

Source: Kenanga