We initiate coverage on  BIMB with a BUY and MYR4.90 FV, premised on its position as a proxy to the growth of Islamic finance. We deem it more attractive  than  peers, given  its  superior financing growth, conservative underwriting,  high  CASA  and  fee-based  income.  Full  recognition  of Bank  Islam’s  earnings  will  boost  upside  potential.  Our  SOP-derived, fully-diluted FV implies a 17x FY14F P/E and 2.0x P/BV.

• BUY, with  11% upside.  We initiate coverage with a SOP-derived, fullydiluted  MYR4.90  FV  –  implying  a  FY14F  P/E  of  17x  (sector  average: 12x).  BIMB  has  re-rated,  trading  at  +2SD  historical  P/E  and  P/BV,  on positive  reaction  to  recent  corporate  developments.  We  believe  it  will continue  to  command  above-trend  multiples,  supported  by:  i)  superior pre-provision  operating  profit  (PPOP)  growth  vs  peers,  ii)  Syarikat Takaful  Malaysia  (STMB  MK,  BUY,  FV:  MYR12.00)’s  high  valuations, and iii) being a proxy to the growth in Islamic finance.
• Two crown jewels. BIMB’s full acquisition of the remaining 49% stake in Bank  Islam  will  have  positive  impact  on  longer-term  ROE.  Earnings growth  will  also  be  augmented  by  strong  annuity  income  from  61%-owned STMB, which underpins its high 40% non-financing income ratio.
• Above-industry  financing  growth.  More  efficient  management  of  its balance sheet,  with financing-to-deposit ratio (LDR)  rising  to 65%  (4Q12: 62%),  has  enabled  Bank  Islam  to  outperform  the  industry’s  financing growth  since  4Q11.  Although  management  has  tweaked  its  financing growth  target  (20%  vs  25%  earlier;  RHBRI  estimate:  +17%)  on  tighter household lending  measures,  we believe the bank can sustain financing growth  above  the  industry  average  (2014F:  +10-11%)  given  its  already conservative financing criteria, and supported by its Tier-1 capital ratio of 13%. Our conservative forecast takes into account potential hiccups from possible regulatory changes on Islamic contracts. BIMB being a pioneer in Islamic banking, and the absence of integration (M&A) risks, will help the  bank  weather  through  regulatory  risks.  Asset  quality  is expected  to remain stable, with GNPL ratio at <1.4%.  Net  financing  margin (NIM)  slippage to moderate.  Bank Islam’s  NIM fell 78bps to 2.84% in 3Q13  (1Q12:  3.62%)  on  the rollout of lower-yield floating  rate  products  and  more  high-cost  deposits.  We  expect  NIM compression  to moderate  as growth in floating  rate  products  slows while current account, savings account (CASA) ratio sustains at c.35%.

Investment Highlights – Summary

ROEs set to  rise,  plugging minority leakages. BIMB acquired  the remaining  49% stake  in Bank Islam  at  end-2013  for MYR2.9bn. This  was  funded by  the issuance of 2-for-5 rights, warrants and a 10-year sukuk. The deal  will allow the group  to take full advantage  of  the  growth  potential  of  its  banking  unit.  We are  positive  on  the  deal, which  is  expected  to  improve  its  longer-term  ROE  beyond  >13%,  and  is  highly earnings-accretive – by 65-78% – in the near-term. The stock has re-rated, trading at +2SD historical P/E and P/BV, on positive reaction to corporate developments.  Bank Islam  has set  targets  to outperform  the  industry,  which  we  believe  are  achievable, while STMB, its takaful  unit, is poised to maintain high ROEs  at ~24% in the coming years.  The former is already a major contributor to  BIMB’s  revenue and  profit before zakat and tax (PBZT) at >80%. Financing  growth  still superior  (as above).  BIMB’s 30% y-o-y growth was higher than the banking industry’s 9%.  Its financing growth has been outpacing  the  banking industry since 4Q11.

Firstly,  BIMB leverages on  its  LDR,  which is low at  65% vs the industry’s 83%. Secondly,  we believe its  already conservative approval criteria helps limit  the  downside risks arising from  the  recent  tightening  on  household lending.  For the same reason, we believe BIMB may chip into the retail lending share of its peers. In addition,  the group sees opportunities in infrastructure financing and refinancing of conventional  loans  into  sukuk  financing.  Taking  into  account  a  more  stringent regulatory  environment,  Bank  Islam  has  set  its  financing  growth  at  a  conservative 20%, which is also supported by its current Tier-1 equity ratio of 13%. NIMs compression at a moderate pace.  As at 3Q13, BIMB posted  the highest NIM (at 2.9%)  vs that of  its peers.  We expect NIMs  compression  to moderate,  following a period of  decline in  asset yields,  its  higher  proportion of floating-rate financing  and increased COF.  Further compression is expected from competitive pressures, but at a  normalised  pace. 

We  expect  BIMB’s  NIMs  to  remain  consistently  above  that  of industry  NIMs,  as  its  aim  to  maintain  a  high  exposure  to  profitable  financing segments. While this could prove challenging in the current environment, we reiterate our argument that BIMB may outperform its peers in its retail lending portfolio. Commendable  CASA.  For  the  past  three  years,  BIMB’s  CASA  ratios  of  37-47% have  been  consistently  above  the industry average of 25%. We understand  that the CASA  deposit  base  comprises  Government  bodies/agencies  and  religious associations  through  LTH.  These  customers  should  help  sustain  a  recurring  30% CASA  ratio  vs  management’s  target  of  35%.  To  mitigate  a  CASA  downtrend,  the group plans to secure more CASA from its large customer base, particularly from the young  professionals  segment.  CASA  management  is  a  key  target  for  BIMB  to alleviate recent concerns over the increasing COF.

Enhancing  non-financing  income.  BIMB’s  NFI  contributed  40%  of  its  3Q13  total income.  The  bulk  of  its  ancillary  income comes  from strong  recurring  contributions from  STMB,  its  takaful  subsidiary.  We  expect  the  latter  to  grow  at  12%  earnings CAGR  through  FY13F-15F.  Excluding  STMB,  its  NFI  ratio  stands  at  13%,  slightly below  its  target  non  fund-based  income  ratio  of  15%.  Management  attributes  the opportunities to boost its  NFI  to  the  growth in  its  merchant-based business, trading and a strong pipeline in the capital markets.

Improving  asset  quality.  Gross  NPL  declined  to  1.36%  in  2Q13  from  the  22.0% high  seen  in  FY05-06,  aided  by  an  efficient  cleanup  of  its  balance  sheet  and substantial writebacks. In addition, its  above-industry provisioning buffers  are  in line with its prudent underwriting standards. We opine that BIMB’s current gross NPL is at comfortable levels,  given its large retail portfolio.  The group guided that the financing recovery/writebacks  will  not  be  substantial  moving  forward,  which  suggests  that further  improvements in  its gross NPL will  not be  significant.  Also,  credit costs  may normalise  to  30-40bps  (FY12:  33bps),  as  management  guided  that  collective assessment, or provisioning, may increase to cover higher-risk accounts from the low base. Our credit costs assumption is at the conservative end of the 35-40bps range.

• BIMB  was  formed  to  answer  the  call  for  a sustainable  Islamic  financial  system  during the 1980s
• The  special  relationship  with  its  ultimate shareholder, LTH, allows for synergies

Pioneer Islamic financial institution.  BIMB was established in 1997 as a holding company  for Malaysia’s  pioneer  shariah-compliant  entities,  although  the  group’s history actually dates as far back as 1983 with the incorporation of 51%-owned (as at end-2012) Bank Islam.

The  latter  was  set  up  with  an  initial  paid-up  capital  of  MYR80m  following  the enactment of the Islamic Banking Act  1983  to  create  a competitive Islamic  financial system.  As  Malaysia’s  first  Islamic  bank,  Bank  Islam  became  the  first  public-listed Islamic financial institution on the Main Board of the Kuala Lumpur Stock Exchange in 1992.  By comparison, the country’s second Islamic bank, Bank Muamalat, is much younger, having been incorporated in 1999.

The group’s 60%-owned  takaful  subsidiary, STMB, was incorporated in 1984 with an initial paid-up capital of MYR10m, following the enactment of the Takaful Act  1984. STMB remains the first and only pure public-listed takaful operator in Malaysia. 

A  Tabung  Haji  arm.  LTH,  a  50-year  old  pilgrimage  fund,  is  BIMB’s  ultimate shareholder,  with  an  aggregate  holding  of  51%.  This  partnership  extends  beyond international  investors  like  the  Dubai Financial  Group  (DFG),  whic h  invested  about 30% in Bank Islam as a result of a 2005 recapitalisation exercise.

BIMB’s  special  relationship  with  LTH  opens  the  door  to  immediate  synergies, including  business  referrals  for  corporate  financing,  depositors,  sukuk  underwriting capabilities and strong ties with Government-linked companies.

Crown Jewel 1: Bank Islam Malaysia

• Bank Islam emerged as a stronger bank after its  makeover.  The  next  phase  of  its transformation  is  equally  focused  on  high business growth and sustainability
• Bank Islam’s growth trajectory is that of a retail bank

Stronger after recapitalisation.  Bank Islam’s transformation began after it  reported losses  of  MYR0.5m  and  MYR1.3m  in  FY05  and  FY06  respectively.  Profits  were wiped  out  by  provisions,  as  its  NPL  ratios  jumped  to  20-22%.  A  recapitalisation exercise in Oct 2006 involved a MYR1bn capital injection from LTH and DFG. This  was  followed  by  a  clean-up  of  its  balance  sheet,  the  installation  of  a  new management  team  and  full-scale  reorganisation,  as  stipulated  in  its  3-year turnaround  plan  (2006-2009).  In  2009-2012,  BIMB  returned  to  profitability,  with margins  stronger  than  ever.  This  was  supported  by  substantial  improvements  in financing  growth,  asset  quality,  risk  management  and  operational  processes.  2013 marked  the  start  of  the  group’s  H2E  plan,  which  emphasised  high,  sustainable business growth.

Highlights  of  key  synergies.  Bank  Islam  is  the  third-largest  Islamic  bank  in Malaysia  with  assets  amounting  to  MYR42bn  and  a  customer  base  of  >3.5m.  Its growth  trajectory  is  that  of  a  retail  bank,  as  it  is  able  to  leverage  on  LTH’s  retail network of  ˃ 8.2m  depositors.  In the past, innovative and convenient initiatives were introduced  to  customers  performing  transactions  between  LTH  and  Bank  Islam accounts. Integration  services  of both accounts were also enforced through  68  ATM machines at LTH branches. The bank also provides debit card services during the haj season.  It  also leverages on  financing demands  from  Government agencies, as well as  education  financing  for  the  Perbadanan  Tabung  Pendidikan  Tinggi  Nasional (PTPTN).

Source; RHB