Banking stocks’ rally last week together with recent consensus earnings cuts means that PE valuation for some banks are now higher than end-2019. As such, we have attempted to gauge the ranges that banks’ share prices could potentially trade up to, based on Global Financial Crisis-era and more recent PE ranges. Potential upside seems limited for Affin, while ABMB, AMMB and CIMB appear to have some headroom for further appreciation. Maintain NEUTRAL sector call with RHB as our top pick.

Banking stocks enjoyed a catch-up rally last week, where the sector (based on the main eight banking stocks) rose 10.5% for the week, as compared to 5.6% gain for the FBM KLCI. Consequently, the sector is now up 23.9% from its low in Mar (FBM KLCI: up 27.6%) but on YTD basis, it is still down 11.6% vs FBM KLCI: -2.0%. We believe the recent rally was fuelled by a combination of liquidity, rotational play into cyclicals and possibly, more optimistic prospects ahead. We noted that other regional markets have also seen their banking stock prices pick-up.

On the other hand, post the 1QCY20 reporting quarter, consensus had reduced sector CY20E/CY21E net profit by 12%/8% respectively. As compared to CY20E/21E projections at the beginning of the year, current sector CY20E/21E net profit is lower by 22%/18. Major earnings downgrades were made for CIMB (UP; TP: RM3.45) (FY20E/FY21E: -28%/-16%) and Maybank (MP; TP: RM7.85) (-14%/-8%) during the May results period, while for the other banks, earnings were revised down but by a lesser extent of up to 8%. The earnings cuts coupled with last week’s share price action means that CY20E PE for banking stocks now range between 7.0x to 14.1x as compared to 7.3x to 13.3x at the beginning of the year.

Taking a look back at the Global Financial Crisis (GFC), we set out in Figures 9-16 the trends between share price performance, PE and profitability. Some key observations are: (i) Share prices bottomed out around three to six months ahead of earnings; (ii) Strong PE multiple expansions subsequently as share prices reacted positively to improved earnings prospects; (iii) PE multiple expansion can last for slightly over a year before multiples start to de-rate in line with slowing growth rates; (iv) Banks PE multiples since the GFC have traded at a much narrower range, largely a function of slower growth; and (v) Ultimately, share price performance tracks earnings direction.

We have attempted to estimate the range of prices banks may potentially trade up to, based on observed PE levels during the GFC, as well as more recent PE ranges. We highlight the poor earnings visibility for banks at this stage, and this impacts our attempted estimates. In Table 4, we identified the individual banks’ trailing PE highs during the GFC and their corresponding 1-year forward PE, which reflects the growth trajectory ahead. Ascribing this similar 1-year forward PE to consensus CY21E EPS, we derive a range of potential prices the banks could trade up to. These ranges vary widely from a potential downside of 13% (Affin (UP; TP: RM1.45)) to a potential upside of 78% (AMMB (OP; TP: RM3.60)).

Using more recent PE levels for the banks, the potential upside based on 3-year high PEs ranges between 8% (Affin) and 89% (ABMB (OP; TP: RM2.60)) (see Table 5). Apart from ABMB, banks that appear to stand out with attractive upside potential are AMMB and CIMB. Admittedly, CIMB looks like a tempting trade based on the above PE valuation matrices. At this stage, however, we prefer to keep our more conservative stand on the stock as we think earnings risks are relatively higher as the group has fewer levers to push to support earnings (and capital, e.g. lack of regulatory reserve buffers) while its Indonesia exposure may drag the loan impairment cycle well into 2021. Notwithstanding the results above, we highlight that PE levels this time may not necessarily reach similar levels as that in the past due to, for instance, structural organisational changes (e.g. CIMB) and slower growth rates ahead, among others. .

Maintain NEUTRAL sector call. As highlighted above, we think banks earnings ahead remain uncertain and volatile, as a combination of factors such as Day One modification losses and rising credit cost kick in. The path to recovery too is unlikely to be clear cut. In mitigation, the re-opening of the economy and significant cuts to policy rate has helped clear some overhang for the sector.

In this report, we have rolled forward valuations to CY21 and reduced our equity risk premium by 25bps, as updated guidance from banks have helped to provide some context to the outlook ahead, while recent earnings cuts have also aided in lowering some earnings risks. RHB (OP; TP: RM6.00) remains our preferred pick. It will be facing a tougher operating environment ahead with a solid balance sheet while asset quality appears to be holding up relatively better than peers CIMB and Maybank. Its best in class capital level helps support management’s commitment to sustaining 2019’s DPS of 31.0 sen, which should provide a floor to share price. We upgrade AMMB to OUTPERFORM from MARKET PERFORM as it has been a laggard and valuations look cheap (CY21E PE of 7.3x is lower than smaller peers Affin (9.7x) and ABMB (7.6x)). As such, AMMB could be an attractive catch-up play. For a more defensive tilt, we prefer HLBK (OP; TP: RM17.00) over PBANK and add the stock to our OUTPERFORM list. Apart from strong asset quality, we think its digital infrastructure puts the group in a better position to benefit post-Covid-19. Near-term upside risk to our sector call is a liquidityfuelled rally and/or rotational plays into value/cyclicals, as well as better-than-expected macro data. Near-term downside risk is the emergence of Covid-19 second wave.

Source: Kenanga Research - 9 Jun 2020