We maintain SELL and an unchanged MYR5.20 TP (10.3% downside) on CIMB.  CIMB unveiled last Friday its mid-term strategy with the target of lifting ROE to 15% by 2018 (9M14:  11.6%, annualised). This would entail cost restructuring initiatives for IB and  revenue uplift from the buildup of  key  businesses.  We  think  execution  risk  is  high  and  the  possiblefrontloading of restructuring costs means 2015F earnings are at risk.

Mid-term strategy plan revealed.  CIMB announced on6 Feb its  new mid-term  strategy  plans  and  key  orgaisation  changes  (referred  to  as T18,  ie  Target  2018).  The  plans  entail  a  reorganisation  exercise, accelerated buildup of certain divisions (to provide PBT uplift of MYR1bn over three years) and cost restructuring initiatives (reducing  investment bnking  (IB)  cost  by  30%).  All  these  would  then  feed  into  the  group’s 2018 targets of:  i) ROE >15%;  ii) CET-1 >11%;  iii) CIR < 50%; and  iv) consumer banking to contribute c. 60% of income.

Execution risk is high.  9M14 cost-to-income ratio (CIR) for IB stood at 96%. We believe the high CIR is partly structural and partly caused by the weak capital markets. Our estimates suggest that reducing IB costs by 30% coupled with the revenue uplift from the accelerated  buildup of certain  divisions  could  help  CIMB  achieve  its  <50%  CIR  target.  That said, we think execution risks are also high and CIMB’s recent execution track record has been somewhat  mixed. Recall that the 50% CIR was a 2015 target (9M14 CIR: 58%) that was set back in 2012.

Leverage the missing link to ROE target?  Even if CIMB successfully reduces its  CIR  to <50%  by 2018,  ou  rough  calculations suggest  that the 15% ROE target  could still be missed unless leverage is raised.  We currently project 2014-16 ROEs to fall to 10.6-11% from 15.4-16.2% in 2010-13. This is due to a combination of lower ROAs (c. 1% vs 2010-13: 1.3-1.4%) as well as lower leverage (10.2-11.3x vs  2010-13: 11.5-12x). In order to raise ROE to the 15% mark, we estimate leverage may need to rise back to c. 11.5x. This may require further optimisation of the asset portfolio but again, means an additional moving part to the ROE target.

Forecasts  and  investment  case.  We  keep  our  earnings  forecasts  for now  but  think  downside  risks  to  our  2015F  numbers  are  rising.  The ‘clean-up’  exercise  for  the  loan  portfolio  is  expected  to  spill  over  into 1Q15, which may lead to credit costs staying elevated .  Also, we would not be surprised if the reorganisation  and restructuring initiatives involvesome frontloading of costs in  2015.  Hence, we retain  our SELL  call with an unchanged GGM-derived TP of MYR5.20. 

Reveals Mid-Term Strategy To Lift ROE Back To 15%
Mid-term  strategy  plan  revealed.  CIMB  announced  on  6  Feb  its  new  mid-term strategy plans and key  organisation changes. Referred to as T18 (Target 2018), this is  the  product  of  a  strategy  review  exercise  that  began  in  Jan  2014  and  is  now moving into the implementation stage. According to CIMB, 2015 will be a transitional year for the group to recalibrate its operations and thereafter, it will have three full years to achieve its 2018  financial targets, which  are: i) ROE >15%; ii) CET-1 >11%; iii) CIR < 50%; and iv) consumer banking to contribute c. 60% of income. In addition, CIMB said that its mid-term strategy also entails consolidation and measured future growth. Hence, it will not be looking for M&A opportunities except minor ones to help the group complete its ASEAN footprint.

The key initiatives of T18 include:
1.  A  reorganisation  exercise  that  will  see  the  creation  of  a  new  Regional Commercial  and  SME  Banking  Division,  an  integrated  Wholesale  Banking Division  combining  IB,  Treasury  Markets  and  Corporate  Banking  to  optimise internal  synergies  and  a  Regional  Consumer  Banking  Division  to  drive consistency and further efficiencies. This reorganisation exercise will also involve personnel changes in key positions as set out in Figure 1.

Other  major  new  appointments  to  be  made  ahead  include  CEO,  Group  Asset Management and Investments and Group Chief Compliance Officer.
2.  To  reassess  the  Asia  Pacific IB  presence and  reduce  the  overall  IB  operating cost by ~ 30% in 2015;
3.  Implement  initiatives  to  lower  CIR  to  below  50%  in  2018.  This  would  involve process changes, automation and improvements in procurement processes;

4.  Accelerate  the  buildup  of  three  key  businesses,  ie.  commercial  and  SME banking, transaction banking and digital banking. CIMB targets a PBT uplift of MYR1bn  (1-1.5%  uplift  in  ROE)  from  these  areas  alone  over  the  next  three years; and
5.  Execute  a  group-wide  exercise  focusing  on  culture  to  strengthen  teamwork across businesses and borders.

Execution is key
Some hints of T18 earlier in group meeting last month.  During the  meeting with analysts last month, CIMB had highlighted that the  key  focus  area ahead is costs. CIMB  admitted  the  issues  faced  currently  are  part  structural  and  part  cyclical, especially  for  IB.  Hence,  management  had  said  that  it  was  looking  at  operational reorganisation  and  some  rationalisation  to  streamline  some  businesses  and  to improve operational efficiencies.

50% CIR target not new.  Back during the 4Q12 results briefing,  CIMB had unveiled its plan to lower the  CIR to  50% by 2015 from 56% in 2012. This would be  driven by a combination of strong income growth and improved cost efficiency.  Unfortunately, structural issues coupled with  weaker capital markets resulted in the ratio rising to 58% in 9M14 instead.

Tackling issue of IB cost structure sufficient to lower CIR to 50%? From Figures 4 and 5  below, the IB division contributed 7% to total income but  made up 13% of total overheads. CIR for IB stood at 96%, hence, its 9M14  PBT contribution  of  just 1% to the group.

Assuming:  i)  CIMB  successfully  reduces  its  IB  costs  by  30%  in  2016  from  2014’s levels; and ii) cost escalation of around 5-6% per annum  for the other divisions, we estimate 2016F CIR could be lowered to 53.5% from our  current 56.1%. Assuming the  annual  5-6%  rise  in  overheads  is  maintained  and  the  uplift  in  revenue  from initiative 4  above  is  realised, our  numbers suggest  it  may be  possible  for  CIMB  to achieve its <50% CIR target by 2018. That said, we believe execution risk is high as it involves both keeping costs in check, as well as revenue uplift materialising.   Also, we note that one of the key business divisions that is expected to drive the revenue uplift is commercial and SME banking. Given the slowdown in lending activities to the household segment and softness in corporate banking, most banks have expressed the intention to grow the SME segment. We expect competition in this segment to be fierce  and  given  that  CIMB  has  traditionally  not  been  a  significant  player  i n  SME banking, penetrating this segment could prove to be a challenge.

Leverage the missing link to ROE target?  Even if CIMB successfully reduces its CIR to <50% by 2018, our rough calculations suggest that the 15% ROE target  could still be missed unless leverage (assets/equity) is raised. From our DuPont analysis in Figure 7, we currently project 2014-16 ROEs to fall to 10.6-11% from 15.4-16.2% in 2010-13. This is due to a combination of lower ROAs (c. 1% vs  2010-13: 1.3-1.4%) as well as lower leverage (10.2-11.3x vs 2010-13: 11.5-12x). 

Our rough estimates point to an uplift of 30bps in ROAs by reducing IB costs as well as stronger PBT contribution from SME, transaction and digital banking. Assuming a leverage of 10.5x, ROE would only be about 13.8%. In o rder to raise ROE closer to the  15% mark,  we  estimate  that  leverage  may  need  to  rise  back  to  around  11.5x. This  may  involve  further  optimisation  of  the  asset  portfolio  but  again,  means  an additional moving part to the ROE target.

Risks
The  risks  include:  i)  stronger-than-expected  loan  growth;  ii)  better-than-expected 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  are  keeping  our  earnings  forecasts  unchanged  at  this  juncture,  but  think downside  risks  to  our  2015F  numbers  are  rising.  Firstly,  management  had  earlier warned that the ‘clean-up’ exercise in 4Q14 for CIMB Niaga’s coal portfolio as well as the  domestic  corporate  book  is  expected  to  spill  over  into  1Q15,  al though  the quantum  should  not be  as  significant  in  1Q15.  Guidance on  2015F  credit  cost  will only be provided in the upcoming 4Q14 results briefing. Secondly, we would not be surprised if the reorganisation and restructuring initiatives involve  some frontloading of costs in 2015.

Valuations and recommendation
No change to our GGM-derived TP of MYR5.20. Our GGM assumes: i) cost of equity of  10%;  ii)  long-term  growth  of  5%;  iii)  sustainable  ROE  of  10.5%;  and  iv)  FY15F book  value/share  of  MYR4.79.  Our  TP  is  based  on  a  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%  (2015F-16F)  ahead  due  to  lower  returns  and  more  stringent capital requirements vs the 10-year average ROE of 14%.

On the whole, CIMB’s T18 targets appear reasonable, especially if the milestones (egCIR <50%) can be achieved. Nevertheless, as mentioned above, execution risks are high and  CIMB’s recent execution track record has been somewhat  mixed.  Finally, the  risk  of  earnings  disappointment  for  2015  appears  to  be  rising,  as  highlighted above. Hence, we are retaining our SELL call on the stock.

Our  preferred  pick  for  the  sector  is  Public  Bank  (PBK  MK,  BUY,  TP:  MYR21.00), whose  earnings  predictability  is  good  (eg  less  reliant  on  markets-related  income), backed  by  sound  asset  quality  and  cost  efficiency.  Post  last  year’s  rights  issue, Public Bank is also one of the better capitalised banks.  

Source: RHB