We downgrade  our call on CIMB to  SELL  from Neutral, with a revised GGM-derived TP of MYR5.20 (11.4% downside). This is after we lowered our  2014-2016  net  profit  forecasts  by  6.5-7.5%,  as  CIMB  warned  of higher  loan  provisioning  and  softer  revenue  growth  expectations ahead. Even then, we think there is still downside risk  to earnings,  with markets-related income and asset quality as key risk areas.

4Q14  to  see  books  cleaned  up.  Management  warned  that  4Q14  is going  to  be  a  ‘bad  quarter’  due  to  higher  loan  provisioning  for  CIMB Niaga’s  coal  portfolio  as  well  as  some  provisioning  for  its  domestic corporate  book.  The  ‘clean-up’  exercise  is  expected  to  spill  over  into 1Q15, although the quantum should not be as significant then. With that, CIMB said that its loan loss coverage should rise to >80% from 74% as at 30 Sep 2014. There was no guidance on 2014 credit cost except that it  would  be  “higher  than  the  usual  run  rate”,  while  guidance  for  2015 credit cost will only be provided in the 4Q14 results briefing. 

It’s  all  about  costs.  The  key  area  of  focus  ahead  for  CIMB  is  costs. Recall that management had previously set a cost-to-income ratio (CIR) target of 50% by 2015 (from 56% in 2012 while 9M14 CIR was 58%), to be driven by a combination of strong income growth and improved cost efficiency.  However,  given  the  current  environment,  management  has dialled  back  expectations  on  income  growth  and  hence,  the  increasedfocus  on  cost  control.  CIMB  said  the issues faced currently  are  partly structural  and  partly  cyclical,  especially  for  investment  banking  (IB ). Hence, management is looking at operational reorganisation and some rationalisation to streamline some businesses and to improve operational efficiency.

Forecasts.  We lower our 2014-2016  net profit projections by 6.5-7.5% with  the  two  key  revisions  being:  i)  revised  credit  cost  assumption  of 41bps  for  2014F  from  37bps.  This  implies  4Q14  credit  cost  of  65bps (annualised)  vs 3Q14’s 56bps and 4Q13’s 53bps, and ii) a 7-8.5% cut to our 2014-2016 non-interest income projections.

Investment case.  Following the earnings revisions above, we  lower  our GGM-derived TP to MYR5.20 from MYR6.10, and downgrade our call on the  stock  to  SELL  from  Neutral.  We  expect  management’s  guidance yesterday  to  trigger  another  round  of  earnings  downgrades  by consensus. Even then, the downgrade cycle may not have bottomed out. We continue to see markets-related income and asset quality as key risk areas to earnings.

Highlights From Management Meeting

4Q14  to see books cleaned up.  Management warned that 4Q14 is going to be a ‘bad quarter’ due to higher loan provisioning for CIMB Niaga’s coal portfolio as well as  some  provisioning  for  its  domestic  corporate  book.  The  ‘clean-up’  exercise  is expected to spill over into 1Q15, although the  quantum should not be as significant then. With that, CIMB said that its loan loss coverage should rise to >80% from 74% as at 30 Sep 2014.  There was no guidance on 2014 credit cost except that it would be “higher than the usual run rate”,  while guidance  for 2015 credit cost will only be provided in the 4Q14 results briefing.

Notwithstanding the above, management was still comfortable with  the  quality of its domestic corporate loan book. Exposure to the oil and gas segment is about 3.5% of the  loan  book  but  management  thinks  asset  quality  should  still  hold  up  even  with crude oil prices at USD50/barrel.  CIMB was also not overly concerned regarding its exposure to the palm oil and property segments.

It’s  all  about  costs.  The  key  area  of  focus  ahead  for  CIMB  is  costs.  Recall  that management had previously set a cost-to-income ratio (CIR) target of 50% by 2015 (from  56%  in  2012  while  9M14  CIR  was  58%),  to  be  driven  by  a  combination  of strong  income  growth  and  improved  cost  efficiency.  However,  given  the  current environment,  management  has  dialled  back  expectations  on  income  growth  and hence, the increased  focus on cost control. CIMB  said  the issues faced currently are partly  structural and partly  cyclical, especially for IB. Hence, management is looking at operational reorganisation and some rationalisation to streamline some businesses and to improve operational efficiency.

Asset  repricing  a  possibility  ahead.  CIMB  thinks  the  recent  spike  in  spread between the 3-month KLIBOR and overnight policy rate (OPR)  to around 60bps from the  typical  25bps  spread  was  partly  due  to  seasonal  (year -end  competition  for deposits)  as  well  as  regulatory  factors.  Nevertheless,  management  thinks  that  the KLIBOR rate may have peaked. Thus far, asset yields have yet to reprice up for the spike in KLIBOR, but management thinks this could happen sometime in 2H15. If not, CIMB  does  not  rule  out  the  possibility  of  scaling  down  loan  growth  if  loan  pricing becomes uneconomical.

Still  interested  in  the Philippines, but nothing on the table at  this juncture.  The change of rules in foreign bank ownership  –  where the foreign ownership  cap was lifted to 100% from 60%  –  is a positive development for CIMB,  given management’s preference for control. While management does not rule out the possibility of either an  organic  or  inorganic  mode  of  entry,  there  was  not  much  development  at  this juncture.

Risks
The risks include: i)  stronger-than-expected loan growth, ii) better-than-expected  net interest margins (NIMs), iii)  stronger-than-expected capital market activities, iv) asset quality  holding  up  well,  and  v)  favourable  forex  movements,  which  will  positively impact the translation of its foreign subsidiaries’ results.

Forecasts
We lower our 2014-2016 net profit projections by 6.5-7.5% with the two key revisions being: i) revised credit cost assumption of 41bps for  2014F from 37bps. This implies 4Q14 credit cost of 65bps (annualised) vs 3Q14’s 56bps and 4Q13’s  53bps, bringing 
2014F loan loss coverage to 81%, and ii) a 7-8.5% cut to our 2014-2016 non-interest income  projections,  as  we  assumed  more  challenging  capital  market  conditions ahead –  in line with management’s toned down  expectations on revenue growth. We also lower our 2014-2016 net DPS projections to 18.5-21.5 sen from 20-23.5 sen due to the  earnings  revisions. Our  net  payout  assumption is  broadly  the  same, ie  41% p.a. CIMB intends to stick to its dividend payout policy, despite the weaker earnings.

Valuations and recommendation
We reduce  our GGM-derived  TP to MYR5.20 from MYR6.10.  Our GGM assumes: i) cost of equity of 10%, ii) long-term growth of 5% (previously 6%), iii) sustainable ROE of 10.5% (from 11%), and iv) FY15F book value/share of MYR4.79. Our  TP is based on  2015F P/BV of  1.1x, at a discount to the 10-year average of 2x. We think this is fair,  given  lower  projected  ROEs  of  10.6-10.7%  (2015-2016)  ahead  due  to  lower returns and more stringent capital requirements vs the 10-year average ROE of 14%.

We expect management’s guidance yesterday to trigger another round of earnings downgrades  by  consensus  but  even  then,  we  think  there  is  still  downside  risk  to earnings with markets-related income and asset quality as key risk areas. Valuation-wise, CIMB currently trades at 2015 P/BV of 1.23x. By our estimates, this implies  that  the  market  is  prici ng  in  ROE  expectations  of  about  11.3%  ahead, compared with  our 10.5-11% ROE expectations. Hence, we see room for a further de-rating ahead. Overall, we downgrade our recommendation on the stock to SELL from Neutral.

Source: RHB