CIMB, RHB and MBSB announced yesterday that the proposed  merger of  the  three  parties  has  been  aborted.  We  are  resuming  coverage  on CIMB with a NEUTRAL recommendation and MYR6.10 TP (6% upside).With  the  merger  distraction  out  of  the  way,  we  expect  focus  to  shift back to fundamentals, which remains  challenging amid tighter liquidity as well as uncertainties over capital markets and asset quality.

Ceasing  discussions on  proposed  merger.  CIMB,  RHB  (RHBC  MK, NR)  and  MBSB  (MBS  MK,  NR)  yesterday  announced  that  the  parties have ceased discussions on a proposed merger and creation of a mega Islamic bank. The decision to abort discussions  was attributed to revised expectations  regarding  potential  merger  synergies  that  could  be delivered, especially in light of the current economic conditions. 

Focus back to fundamentals…  With the merger distraction out of the way,  focus  should  shift  back  to  fundamentals.  2014  has  been  a  tough year for  CIMB amid muted capital markets while the need to shore up CET-1 capital had put further pressure on EPS and ROE. Consequently, management  had  said  in  its  3Q14  results  briefing  that  its  2014  ROE target of 13.5-14% will not be met. 

…which remains challenging. However, CIMB had appeared optimistic that markets-related income would improve in 2015, citing expectations of better investment banking  (IB)  activities,  a healthy debt capital market pipeline  as  well  as  market  share  gains  across  the  region  in  terms  of forex.  While we have modelled in a recovery in non-interest income for2015,  visibility is, admittedly,  still poor given the weak market sentiment and a rising bond yield environment. Apart from that, system liquidity has tightened, which would put funding cost under pressure while concerns over asset quality are likely to linger given the  weaker macro backdrop coupled with higher inflation and interest rates.

Forecasts.  We project 2015 net profit growth to rebound to +13% YoY (2014F:  -10% YoY), driven by a recovery in non-interest income (+11% YoY), stable credit cost of 36bps and  the  base effect. However, we see 2015F ROE being diluted further to 11.3% from 11.8% in 2014F due to last year’s MYR3.55bn capital-raising exercise.

Investment  case.  We  are  resuming  coverage  on  CIMB  with  a NEUTRAL  call  and  GGM-derived  TP  of  MYR6.10.  We  see  income growth and asset quality as key risks to our forecasts but on the flip side, CIMB enters 2015 on a stronger footing in terms of capital.

Proposed merger aborted, back to fundamentals

Ceasing  discussions  on  proposed  merger.  CIMB,  RHB  and  MBSB  yesterday announced  that  the  parties  have  ceased  discussions  on  a  proposed  merger  and creation of a mega Islamic bank. The decision to abort discussions was attributed to revised  expectations  regarding  potential  merger  synergies  that  could  be  deliv ered, especially in light of the current economic conditions.

Focus  back  to  fundamentals...  With  the merger  distraction  out  of  the  way,  focus should  shift  back  to  fundamentals.  2014  has  been  a  tough  year  for  the  banks generally as income growth was a struggle amid net interest margin pressure as well as  muted  capital  markets,  among  others.  The  need  to  shore  up  CET-1  levels  put further pressure on EPS and ROEs. CIMB was not spared from the above. During its 3Q14 results briefing, management had said that its  2014 ROE target of 13.5-14% will  not  be  met  given  the  challenging  outlook  for  Indonesia  and  weaker  capital markets.  CIMB  had  guided  for  the  near-term  outlook,  ie  4Q14,  to  be  stable  for Malaysia and Thailand, negative for Indonesia but positive for Singapore. In terms of business  segment,  the  outlook  is  stable  across  the  majority  of  the  businesses  but CIMB  was  more  cautious  on  regional  corporate  banking  due  to  Indonesia. 

Management  believes  asset  quality  in  Indonesia  could  see  further  deterioration  in 4Q14  but  expects some  improvement  in  2015.  CIMB  also  appeared optimistic  that markets-related  income  would  improve  in  2015,  citing  expectations  of  better  IB activities in 1H15 compared to 1H14 and 2H14. The debt capital market pipeline was healthy while the group has gained market share in terms of forex across the region.

…which remains challenging. While we have modelled in a recovery in non-interest income for 2015, visibility is still poor given the weak market sentiment and a rising bond yield environment.  Apart from that, we see the following  key challenges ahead for  the  sector:  i)  a  softer  macro  environment  –  we  expect  real  GDP  growth  to moderate  to  5%  in  2015  from  5.8%  in  2014  as  the  introduction  of  the  goods  and services tax (GST) and lower oil prices will likely lead to a more moderate increase in consumer  spending  and  private  investment,  ii)  income  growth  –  the  softer  macro environment means we project system loan growth to ease to 8-9% for 2015 from 9-10% for 2014. Meanwhile, net interest margin (NIM)  remains under pressure largely from funding cost due to the ongoing re-pricing of fixed deposits, tighter liquidity and regulatory  requirements.  Markets-related  income  is  also  a  question  mark,  and  iii) asset quality  –  a  weaker macro backdrop  coupled with higher inflation and interest rates  as  well  as  lower  crude  oil  prices  should  see  asset  quality  (especially  for  the corporate segment) remain in the spotlight.

Risks
The  risks  include:  i)  slower-than-expected  loan  growth,  ii)  weaker-than-expected NIMS, iii) weaker-than-expected capital market activities, iv) a deterioration in asset quality, and v) adverse foreign exchange movements, which could  adversely impact the translation of results of its foreign subsidiaries.

Forecasts
We  project  2015  net  profit  growth  to  rebound  to  +13%  YoY  (2014F:  -10%  YoY), driven by a recovery in non-interest income (+11% YoY), stable credit cost of 36bps and  the  base  effect.  However,  we  see  2015F  ROE  being  diluted  further  to  11.3% from 11.8% in 2014F due to last year’s capital-raising exercise.

Valuations and recommendation
We are resuming coverage on CIMB with a  NEUTRAL  call and TP of MYR6.10. Our valuation  methodology  is  based  on  the  Gordon  Growth  Model  (GGM),  which assumes a 10% cost of equity, 11% ROE and 6% long-term growth. Our TP implies 1.24x 2015F P/BV, at a discount to the 10-year average of 2x. We think the discount is  fair  considering  that  ROEs  are  expected  to  trend  down  ahead  due  to  more stringent capital requirements, among others. CIMB’s historical 10-year average ROE was 14% vs our 2015-2016 ROE projections of 11.2-11.3%.

Source: RHB