We expect FY18 earning to be challenging due to higher credit costs with subdued loans growth. Our TP and call is revised downwards to UNDERPERFORM with a lower TP of RM3.79 despite rolling over our valuation base year to FY18 due to lower estimated ROE, hence target price multiples.

Lacklustre topline. 9M17 net profit was within expectations accounting for 76%/74% of our/consensus estimates with a marginal improvement of +0.6% YoY. Overall performance was lacklustre as top-line improved by just 2.9% YoY dragged by falling Net Interest Income (NII) and Non-Interest Income (NOII) at 0.3% and 2.0%, respectively. Solid improvement in Islamic Banking income at 20.6% mitigated the lacklustre revenue. Healthier NIMs of 2bps higher YoY (vs. our flattish estimation and guidance for maintained NIMs) mitigated the fall in NII as loans only grew by 1.5% YoY (vs. management’s guidance of mid-single-digit loans growth). The improvement in NIMs was attributed to efficient funding mix and Fixed Deposits repricing. Stronger deposits growth of 4.2% YoY pushed loan-to-deposit ratio (LDR) lower by 230bps to 86.6%. (vs. Industry’s loans/deposits at +5.3%/+1.5% YoY and industry’s LDR of 90.6%). As top-line outpaced opex (+0.5% YoY), cost to Income ratio (CIR) fell 110bps to 46.3%. (vs. industry’s 48.9%). Asset quality was mixed with Gross Impaired Loans ratio (GIL) improving by 10bps to 1.0% (vs. industry’s 1.6%) but credit cost up by 8bps to 0.23% (attributed to higher provisioning of personal loans in Q3) but lower than management’s guidance of 25-30bps. ROE was lower by 80bps to 10.6% (within management’s guidance of 11%) attributed to higher shareholders’ fund by +6.9% YoY.

Challenging FY18. We expect FY17 earnings to be lacklustre driven by contained costs and healthier NIMs. We expect healthier NIMs with current LDR prompting stable funding costs. We, however, expect FY18 earnings to be challenging due to: (i) higher opex as management roll out new innovative products, and (ii) higher allowances for impairments. Management guided for FY18 CIR of >51% and credit costs of between 30-35bps. No guidance for FY18 loans growth but management is banking on new value propositions to be launched in 4Q17 and 3Q18 to drive loans. We make slight changes to our assumptions of: (i) loans growth at 4-5%/6% for FY17/FY18 (revised downwards from 8% for both), (ii) deposits to grow at 5% for both FY17/FY18 (from 6% for both), (iii) NIMs improving by 4bps for FY17 and another 4bps for FY18 (previously flattish for both years), and (iv) credit costs at 20bps/30bps for FY17/FY18 (previously at 20bps for both FY17/FY18).

Earnings forecasts revised. As there a few changes in our assumptions for FY17/FY18, earnings are revised by 1%/-11% to RM524m/RM496m. Lower FY18 was due to higher opex and impairment allowances of 120% and 9% respectively.

Target Price and call revised. Our revised TP is now RM3.79 (from RM3.97 previously) as we roll over our valuation base to FY18 with blended FY18E PB/PE ratio of 1.05x/11.9x (previously FY17E PB/PE ratio 1.11x/12.4). The lower targeted multiples are to reflect lower ROEs ahead. With earnings challenging ahead, we downgrade AFG to UNDERPERFORM.

Downside risks to our call are: (i) lower-than-expected margin squeeze, and (ii) higher-than-expected loans and deposits growth, and (iii) worse-than-expected deterioration in asset quality.

Source: Kenanga Research - 23 Feb 2017