The sector‘s outlook is challenging due to external concerns while clarity and direction on the domestic front remain murky. With no fundamental change expected and lacking any concrete catalysts, we are inclined to maintain a Neutral stance for the sector. The global and domestic uncertainties are causing concerns of moderate loans growth and soft capital market activities ahead. So far, banks in our universe have been supported by lower impairment allowances and likely to remain so due to normalization of credit charge ahead. Our NEUTRAL stance is kept unchanged as potential total return in our banking universe is still <7%. However, we have OUTPERFORM call for most of the banks under our coverage, i.e. AFFIN (TP: RM2.60), ABMB (TP: RM4.40) BIMB (TP: RM5.05), CIMB (TP: RM6.05), MAYBANK (TP: RM9.75), MBSB (TP: RM1.25) and RHBBANK (TP: RM5.75). The remainders are rated as MARKET PERFORM. Our Top Picks are BIMB and MBSB, both benefiting from undemanding valuations – at the bottom of their respective PBV 5-year mean.

Moving in tandem with the FMBKLCI, the KL Finance Index (KLFIN) YTD, still outperformed the FMBKLCI by 8.5ppt in 2018. Driving the KLFIN were the sharp performances of PBBANK (+19%) and HLBANK (+20%) while the other two heavyweights, i.e. CIMB and MAYBANK, slumped 13% and 3%, respectively. PBBANK and HLBANK have the added advantage of stable and consistent asset quality with Gross Impaired loans (GIL) and credit costs the best performing in the industry. For RHBBANK, receding concerns of its O&G portfolio (with unexpected recovery in impairments) with better-thanexpected NIMs pushed it into 3rd place. For CIMB and MAYBANK, concerns on asset quality from the external front saw both slumping into the negative territory. BIMB was the worst performer for 2019, largely due to concerns of its Sukuk liabilities should a restructuring occur.

Using a blended PBV/ROE: There are asset-based methods of valuation (price to book value ratio or PBV) and earningsbased (PER or ROE) methods of valuation. Here, we blend PBV/ROE valuations, which incorporate both earnings and asset factors into a single ‘metric’. According to the Financial Analyst Journal Vol. 40 1984, investors combine Price/Book (PBV) ratio and return on equity (ROE) to factor in both earnings and net assets of a business when trying to make comparison between valuations of different businesses. This PBV/ROE analysis is also known as the combined asset-earnings valuation framework.

The Price to Book (PBV) ratio is used to value companies as a function of their net asset ownership, which is often regarded as a proxy of liquidation value. Consequently, a common characteristic of low PBV companies is that they are either loss-making or have very poor profitability and this can be very unappealing for certain investors. This is where Return on Equity (ROE) comes in. ROE measures the level of profitability based on the amount of net assets owned by a company. By incorporating ROE, PBV/ROE measures how cheap the assets of the company are in relation to their level of profitability.Figure 3 shows, the industry volatilities and trends signified by its average industry PBV/ROE. In shape 1 (S1), the market was bullish on the banking industry with PBV/ROE ascending steeply targeting a ~12x PBV/ROE. Figure 4 shows all the banking stocks in our universe following this trend. During the period S2, the market was bearish as signified in figure 3 descending to a <11x ratio as most banking stocks were in a downtrend. Mitigating the trend was HLBANK, MAYBANK and PBBANK boosted by in its improving impairment allowances. S3 saw another bearish momentum similar to S2 post GE14 as markets perceived weak business environment due to internal/external headwinds and the market priced a similar low PBV/ROE as S2.

Source: Kenanga Research - 3 Jan 2019